Essays24.com - Term Papers and Free Essays
Search

Du Pont Case Study - Capital Structure

Essay by   •  December 28, 2010  •  1,342 Words (6 Pages)  •  3,274 Views

Essay Preview: Du Pont Case Study - Capital Structure

Report this essay
Page 1 of 6

Du Pont Case Study

Capital Structure

Statement of the Problem

Determine a capital structure policy suitable for Du Pont in the 1980s and beyond. This paper will consider the history of the company and the turbulent times of the 1960s and 1970s, weigh the advantages and disadvantages associated with higher and lower levels of debt, and develop a strategy for the future after the merger with Conoco Inc. in 1983.

Executive Summary

* Du Pont has been historically known for its financial stability and low debt to equity ratio which maximized funding flexibility and protected the business from many financial constraints.

* Competition increased in the 1970s and caused the firm to deviate from its low debt levels and its use of internally generated monies to fund projects.

* They cut their dividend and began using debt as a source of financing. They recognized the problems associated with this and were able to reduce their debt levels and maintain a triple A bond ratio.

* Instead of continuing to reduce their debt to their previous levels, they decided to go in the other direction and used more debt to acquire Conoco Inc., a major oil company, for a very high price.

* This worried investors and the increase in debt downgraded their bond rating to AA for the first time in the company's two hundred years.

* Adopting a conservative capital structure for the future would restore confidence and give the firm greater financial freedom to fund research and development and pursue new projects.

* Given the current of the state of the company, going back to their conservative strategy would be very difficult to attain and require large new equity and stock issues.

* If the company chooses to move to higher leveraged position with more debt they can take advantage of the tax shield created and wouldn't have to issue that much more debt to continue to finance future projects.

* This increased leveraged position brings greater financial risk and less flexibility to finance research and development and fund new projects.

Methodology and Analysis

The task of forming a strategy for a firm's optimal capital structure is not an easy one. Before we can think about planning for the future, we must first consider their history and where they are today (at the end of 1983 in this case). Du Pont de Nemours and Company was founded in 1802 as a gunpowder manufacturer and grew to become the largest supplier of the U.S. military in just fifty years. In fact, their success was continuously linked with that of the U.S. They supplied the Union Army with gunpowder during the Civil War, produced various supplies during WWI and WWII, and played a major role in both the Manhattan Project and the Apollo Space Program. More recently Du Pont has grown and diversified its business mainly through acquisitions and research and development.

Historically Du Pont maintained an extremely low debt ratio, financing new operations with internally generated funds from its past success. This maximized its financial flexibility and protected its businesses from financial constraints. They began to feel competitive pressures in the 1970s and their response put them further in the economic hole. They began a major capital spending program to restore their cost position that grew much higher than expected due to inflation. Increased oil prices increased costs while oil shortages disrupted production. Finally, a recession in 1975 cut prices across the board in Du Pont's fiber business which made up more than one third of its volume.

Attempting to remedy the situation, the firm cut its dividend in 1974 and 1975 and drastically reduced its working capital investment they turned to debt financing. Du Pont's debt-to-equity ratio rose from a conservative 7% in 1972 to 27% in 1975 while the interest coverage ratio fell from 38 to 4.6. The increased debt ratio shows that they were moving towards a higher leveraged position and aggressively financing growth with debt. The reduced interest coverage indicates that Du Pont was now more likely to be unable to meet the required interest payments on its debt.

Even with these financial risks, the company's size, diversity, and history as a leader in manufacturing allowed it to maintain its prestigious AAA bond rating. Through the second half of the 1970s Du Pont was able to reduce its debt ratio to 20% and increase interest coverage to 11.5 which preserved its highest bond rating. This move to financial stability helped satisfy worried investors but the managers at Du Pont knew that to advance their company, they had to use this increased flexibility to make more moves.

In 1981 they entered into

...

...

Download as:   txt (7.7 Kb)   pdf (102.4 Kb)   docx (11.5 Kb)  
Continue for 5 more pages »
Only available on Essays24.com
Citation Generator

(2010, 12). Du Pont Case Study - Capital Structure. Essays24.com. Retrieved 12, 2010, from https://www.essays24.com/essay/Du-Pont-Case-Study-Capital-Structure/26368.html

"Du Pont Case Study - Capital Structure" Essays24.com. 12 2010. 2010. 12 2010 <https://www.essays24.com/essay/Du-Pont-Case-Study-Capital-Structure/26368.html>.

"Du Pont Case Study - Capital Structure." Essays24.com. Essays24.com, 12 2010. Web. 12 2010. <https://www.essays24.com/essay/Du-Pont-Case-Study-Capital-Structure/26368.html>.

"Du Pont Case Study - Capital Structure." Essays24.com. 12, 2010. Accessed 12, 2010. https://www.essays24.com/essay/Du-Pont-Case-Study-Capital-Structure/26368.html.