Capital Structure Assignment

Homework #3

Due: 3/26/2015 by 5:00 p.m.

Capital Structure Assignment

Within your group, each member should provide their financial statements etc. that they calculated in Homework #2. As a group, choose one member’s financial calculations etc. and use them as the basis of the following question. Please include a SHORT discussion of why you chose to use those financial statements (i.e. what are the strengths and weaknesses of the attempt.)

Part 1.) Answer the following question regarding Daktronics: (25 points)

        Evaluate the company’s current debt/equity policy. How much unused debt capacity does the company have? Should the Treasurer borrow more? Why or why not? Discuss the implications of the various theories of capital structure: M&M, M&M with taxes, tradeoff, and pecking order theories for Daktronics’ use of debt. Discuss the advantages and disadvantages of increasing debt in Daktronics.

Based on our financial statement, we are assuming the current year is 2013. The current debt/equity is 0.5847. According to data from 2007 to 2009, Daktronics’ average debt/equity ratio is 1.0036. There is a 0.4189 unused capacity exists.  The reason we are using this financial calculation is that it is the closest to realistic number. In realistic, Daktronics decided to pay special dividends in 2010, 2011, and 2012. In our strategy, we decide to pay dividends semi-annually, with the same price.

M&M:

In M&M proposition, there are no bankruptcy cost and no tax. In the existence of tax, there will be no tax shield benefit from leverage. However, zero bankruptcy cost drives a company to borrow more debt which allows them to finance additional projects which would then result in firm growth. Hence, Daktronics will be in a better position if they leverage more in their capital structure.

M&M with Taxes:

If tax is incorporated in the M&M proposition, this is even better for Daktronics to leverage more as debt actually creates tax shield benefit for the company.

Tradeoff:

In tradeoff theory, it proposes that there is tax shield benefit from debt financing and costs of financing with debt such as bankruptcy cost and non-bankruptcy cost. The marginal benefit of further leverage will start to decline as debt increases over a certain level while the marginal cost start to increase. Hence, a company is recommended to optimize their debt financing by levering to the balance point of the marginal benefit and the marginal cost. However, the company is required to keep an eye on their ability to repay the debt interest and debt principal on due time.