Capital Structure Presentation (Master Slide)

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Capital Structure&

Effect to firm


QUESTION OVERVIEW

DISCUSSION TOPIC REFRESHMENT

CAPITAL STRUCTURE100% Equity100% Debt

Mixture

EFFECT

BENEFIT


Capital Capital StructureStructure(company)(company)

CAPITAL STRUCTURE THEORYCAPITAL STRUCTURE THEORYCONCLUSIONCONCLUSION

EQUITY FINANCINGEQUITY FINANCING

DEBT FINANCINGDEBT FINANCING

FINANCIAL COMPANYFINANCIAL COMPANYANALYSISANALYSIS

CAPITAL STRUCTURECAPITAL STRUCTUREDECISIONDECISION

PRESENTATION OVERVIEW

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22

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55

66


CAPITAL STRUCTURE THEORY

M&MM&M

THEORYTHEORY

TRADE OFFTRADE OFF

PECKING ORDERPECKING ORDER• stating that the market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends.• Two (2) propositions: - Firm Value - WACC

• Is an alternative to the static theory.• Key element is that firms prefer to use internal financing whenever possible.

• deals with the cost of financial distress and agency cost. • corporations are funding by the mixture of debt and equity


EQUITY FINANCING

ADVANTAGESADVANTAGES

EQUITY EQUITY FINANCINGFINANCING

DISADVANTAGESDISADVANTAGES• start-up costs• prospectus• valuable business assistance• does not need immediate repayment and installment• not need to bear the interest• no need to pledge assets to the lender as collateral

• power & control• requirements• demanding, costly and time consuming• Personnel to handle information reporting• Hold periodic mailings and meetings with the investors


DEBT FINANCING

ADVANTAGESADVANTAGES DISADVANTAGESDISADVANTAGES

DEBTDEBTFINANCINGFINANCING

• Ownership• Tax – deductible• Lenders do not share profits• No periodic mailings or meetings.

• Credit rating• Pledge assets to the lender• Has to budget for the principal and interest payment


IndustryCompare

Consult’n Cash FlowAnaly.

ImpactOn

ProfitRiskConsider’n

Capital Structure

Determinants

CAPITAL STRUCTURE DETERMINANTS

CASE ANALYSIS :FINANCIAL INSTITUTION(BANKS)


CASH FLOW ANALYSIS (RATIOs)Debt/equity ratio :Debt/equity ratio :

Measure of firm’s financial Measure of firm’s financial leverageleverage

Total LiabilitiesTotal Liabilities Stockholder’s EquityStockholder’s Equity

High D/E ratio means: High D/E ratio means: • Company’s aggressivenessCompany’s aggressiveness in growth via debt in growth via debt financingfinancing• May result in volatility of May result in volatility of earnings due to additional earnings due to additional interest expenseinterest expense


CASH FLOW ANALYSIS (RATIOs)Cash Flow To Debt Ratio Cash Flow To Debt Ratio (CFTD)(CFTD)

Measure of firms capability to Measure of firms capability to overcome their debts at a overcome their debts at a specified periodspecified period

EBITDAEBITDA DebtsDebts

Higher CFTD indicates betterHigher CFTD indicates better firmfirm


CASH FLOW ANALYSIS (RATIOs)Debt ratio :Debt ratio :

Measure of firms capability to Measure of firms capability to overcome their debts via overcome their debts via assets that are availableassets that are available

Total LiabilitiesTotal Liabilities Total AssetsTotal Assets

Lower Debt ratio indicates Lower Debt ratio indicates better firms better firms


PROFIT ANALYSIS

Breakeven EBITBreakeven EBIT

Indicates the point which Indicates the point which differentiate profitability via differentiate profitability via stock and debt financingstock and debt financing

Shown as the yellow line in Shown as the yellow line in graphgraph


PROFIT ANALYSIS (BANKS)

Breakeven EBITBreakeven EBIT What is it ? What is it ?

- Analysis indicating stock financing or mix - Analysis indicating stock financing or mix financingfinancing What is the accuracy level?What is the accuracy level?

-Indicates higher debt better… Indicates higher debt better… -100% debt is NOT GOOD : financial distress100% debt is NOT GOOD : financial distress


RISK ANALYSIS

IDEAL CASE : IDEAL CASE : 100% debt financing is the 100% debt financing is the BEST (base on graph shown)BEST (base on graph shown)

WITH RISK …WITH RISK …

After a certain point, the cost After a certain point, the cost increases exponentially due to increases exponentially due to agency and bankruptcy cost.agency and bankruptcy cost. (due to high interest cost) (due to high interest cost)


RISK ANALYSIS (BANKS)

RHB CASE ANALYSIS :RHB CASE ANALYSIS :

2006 high D/E ratio compared 2006 high D/E ratio compared to industryto industry

Almost bankrupt, M&A took Almost bankrupt, M&A took placeplace


CONCLUSIONLEVERAGING A FIRM WITH DEBT FINANCING CAUSES :LEVERAGING A FIRM WITH DEBT FINANCING CAUSES :

Increases expected ROEIncreases expected ROE

Increases variability of ROEIncreases variability of ROE

Increases Risk of financial distressIncreases Risk of financial distress

ANALYSIS FOR OPTIMAL CAPITAL STRUCTUREANALYSIS FOR OPTIMAL CAPITAL STRUCTURE

DO RATIO ANALYSISDO RATIO ANALYSIS

DO BREAKEVEN ANALYSISDO BREAKEVEN ANALYSIS

BE CAUTION OF RISK INVOLVED BE CAUTION OF RISK INVOLVED (TRAPPED IN FINANCIAL (TRAPPED IN FINANCIAL DISTRESS)DISTRESS)

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Capital Structure Presentation (Master Slide)