At 30% debt the tax would be 417. 4. Hereford saving the shareholders (455. 2-417. 4) = 37. 8 million. Similarly at 70% debt the company would save shareholders (455. 2-383. 7)= 71. 5 million dollars. 2. What capital structure would you recommend as appropriate for APP? What are the advantages to leveraging this company? The disadvantages? How would leveraging up affect the company’s taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure? From the examples or ratio given in exhibit 3;4 1 would recommend a 70% debt to capital structure.
At this ratio the firm could repurchase 36. 6 million shares and thereby recapitulating and increase the overall value of the firm. They would also provide the tax benefit of 71. 5 million for the shareholders to enjoy. Disadvantages of increasing their debt ratio would mean that the firm is now responsible to repay the loan at certain interest rate. It also exposes their credit rating a bit more since the more they borrow the higher the risk to the lender and could result in the lender increasing their interest rates with time. He taxes are affected through the fact that interest is tax deductible. It was calculated that at 70% there would be a tax saving of 71. 5 million $. There should be a positive reaction from the capital markets since the company previously had no debt and now the capital markets can earn money thought the tersest they charge to the company. Since the company has very low risk and performs well the capital markets also have low risk to the fact that APP will be able to repay their loans.
Exhibit 3 also shows how APS stock price could also rise with if they used a 70 % debt ratio since earnings per share would increase from $3. 18/ share at current debt ratio to $3. 49/share at 70%. 3. How might APP implement a more aggressive capital structure policy? What are the alternative methods for leveraging up? APP could increase their debt ratio by having a capital structure that does not solely Ely on equity and internal financing. Alternative methods for leveraging up include buying fixed assets and using derivatives. . In view of Pap’s unique corporate culture, what arguments would you advance to persuade Mr.. Elaborate or his successor to adopt your recommendation? Would explain how using a combination of debt and equity financing results in shareholders value increasing since there is the benefit from tax reductions and also the probability that the share price could increase. It will also allow the company to repurchase 36. 6 million shares from the market, thus increasing there overall value of the firm.