Introduction
The purpose of this assignment is the analysis of impact of capital structure to the financial performance of the company. The paper contains the information about the changes of company value, of stock value and of earnings per share that depend on the changes of capital structure.
Value of the Company
The more powerful instrument for evaluation of the impact of capital structure changes is a weighted average cost of capital. This value is a very important measure of the company value. The following formula is used to WACC calculations:
where E – is the shareholder’s equity;
D – total debt;
Re- cost of equity;
Rd- cost of debt.
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WACC (the capital structure without debt):
WACC=10 000 00010 000 000*0.11=0.11
WACC (the capital structure with 25% of debt):
WACC=0.75*0.13+0.25*0.09*(1-0.35)=0.112125
The weighted average cost of capital of company with 25% of debt is higher than the weighted average cost of capital of company without debt; it means that the value of company will be increased after recapitalization.
Earnings per Share
EPS=EBIT-Interest Expenses*(1-Tax Rate)Average Outstanding Shares (AOS);
where EBIT – is the earnings before interests and taxes.
As the capital of the company will have 25% of debt after recapitalization and the cost of debt is equal 9%, the annual interest expenses is equal ((10 000 000/0.75) – 10 000 000)*0.09 = 300 000$.
It is necessary to compare the earnings per share of company before and after recapitalization:
EPSbefore=3 880 000*0.65500 000=5.044;
EPSafter=3 880 000-300 000*0.65500 000=4.654.
The result of this calculations and the comparison is that the earnings per share will decrease after recapitalization.
Stock Price
The price of the stock is going to be increased after recapitalization because all shareholders will increase own shares in the company capital. The price of stock can be increased at 33.3%:
Stock price=270.75=36$.
Times Interest Earned Ratio
The times interest earned ratio is a measure of the company ability to pay put the interest payments. This value can be computed using the following formula:
TIER=EBITInterest Expenses;
The table below contains all results for each probability level and presents that the company has a high ability to pay out its debt:
Conclusion
The analysis of capital structure impact on the financial performance of the company indicates that the presence of the debt in the capital has the positive results for company, because it creates the tax shield, that gives the possibility to decrease the tax payouts and to increase the financial performance of the company in long-term period. But these changes in the capital increase the risk of liquidity of the company, because the ability to pay out the debt decreases. So, each company has to form the capital structure taking into account this risk, because the huge portion of debt in the capital can be reason of insolvency of the company.
If we take into account all calculations and values, in this assignment the recapitalization will have the positive results for the company.
Reference list
Ashford University. Hickman, K. A., Byrd, J. W., & McPherson, M. (2013). Essentials of Finance. San Diego, CA: Bridgepoint Education Inc.;
Robert W. Kolb Series (2011). Capital Structure and Corporate Financing Decisions: Theory, Evidence and Practice. Wiley; 1 edition.
Appendix
Table 3 – Time Interest Earned Ratios
