Module 4 Case: Capital Structure Decision and the Cost of Capital

Capital Structure Decision and the Cost of Capital

Introduction

In order to evaluate any company from investment point of view, one of the fundamental element of consideration is company's balance sheet with in which an investor can assess the capital structure and resolve is the company good for investment or not. Capital structure represents how the company management has decided to finance the operations and capital expenditure for long term growth and development. Funding can be done either through equity or debt. Equity represents the shareholders contribution in the company financing while liabilities are external source of funding for the company. The purpose of this essay is to evaluate three companies namely eBay and Clorox on the basis of their capital structure and financial positions and recommend an optimal capital structure for each company. Recommendations are presented for the three companies pertaining to the in the capital structure, on the basis of the nature of business and the riskiness of the companies.

The main objective of any organization is to maximize the shareholder's health. The determination of capital structure, that is the percentage of debt and equity, is one of the most critical decisions in this regard. Theoretically, the optimal capital structure is at the point where the share price of the company is maximum and weighted average cost of capital is minimum (Peterson, 1999). However, the determination of capital structure highly depends upon the nature of the company and cost of capital. Companies with the high cost of debt and leverage are recommended to move towards equity issuance. Debt equity ratio is the tool to measure the percentage of debt over equity. It is calculated by dividing the total liabilities over total equity (Baker, 2002).

 

eBay

 

(In Thousands)

Total Assets

$27,320,218

Current Assets

$12,661,454

Long term Assets

$14,658,764

 

 

Total Liabilities

$9,390,339

Long Term Debt

$1,525,047

Current Liabilities

$6,734,204

 

 

Stockholders' Equity

$17,929,879

 

 

Revenue

$11,651,654

 

 

Debt to equity Ratio

0.12

Profit Margin

27.72

ROA

13.09

ROE

19.44

Betas

1.55

Discussion

eBay

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In 2011, the company generated combined revenue of $11.6 billion. Total assets for the company amount to $27 billion. Debt to equity ratio as per 2011 financial statements is calculated to be 12%. Serving aas aa ameasure aof athe along aterm afinancial astate aof athe acompany, athe acapital astructure agives aan ainsight ato athe arisk aassociated awith aeBay. aThe aratios acomparing aexternal afinancing ato astockholders aequity aare afundamental ain athe aoverall arisk aassociated awith ainvestment ain athe acompany aand aas asuch aare aimportant adeterminants aof athe arequired arate aof areturn aof aboth astockholders ...