Capital Structure

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Capital Structure

The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Capital of company may broadly be categorized into equity and debt. The            total capital structure of a firm is represented in the following slide.

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Our Shadow Firm

I have chosen Apple Inc. as our shadow firm. Apple Inc., is one of the biggest market shareholders in the technology industry. Their products and innovations have made them market leaders in this industry.

To give you a glimpse of the progress and earnings of Apple Inc., below is their Balance Sheet.

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Our Firm

RV GROUP, is an established firms which also strives to introduce technologically advanced equipment for industries. Through increased product innovation and integrating new technologies, RV GROUP , wants to introduce new advanced equipment to reduce time and increase efficiency.

Questions:

1. By looking at the balance sheet of your shadow firm, investigate how the firm has raised capital for investment opportunities. Begin by describing the mix of debt and equity, and calculate the proportions for each source of long-term funds.

Proportions:

Long term debt: 53,463,000 (30.93%)

Equity: 27,416,000 (- 345,000, this is as buy back) (15.67%)

Retained Earnings: 92,284,000 (53.40%)

Looking at the proportions, Apple Inc., has a mix of all the three types of debts.

Major proportion of capital structure is financed by company’s own capital- Retained earnings which is approx. 54%[pic 5].

1. Return to your group’s fictitious firm. Design a balance sheet that approximates the sources and uses of financing of your shadow firm.
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As seen in the Apple Inc., RV GROUP  also finances its funds through their Retained earnings. They also have a good mix of all the three sources of financing.

1. Assign rough cost estimates, rounding where necessary, and calculate the Iighted average cost of capital for your fictitious firm.

Calculation of WACC:

Cost of debt  = Interest(1-Tax) / Net proceeds

2.44 (Before Tax), 1.66(After tax)

(4,474,960(1-.40) / 183,400,000) x 100

Cost of Equity:

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=> COE = 0.23 + 1.44(5.27 – 0.23) = 7.49%

Cost of retained earnings = 7.49%

WACC of Apple Inc. is 9.44%, while the WACC of RV GROUP  Inc. is 7.1376%

1. Design a new investment opportunity and calculate its IRR. Use the cost estimates from part 3 and make a decision with regard to the investment opportunity.

RV GROUP , is planning for a new project. It’s initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and $1,300,000 in year 4

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