Currently, the company’s debt is $110 million, composing approximately 25% of the firm’s capital structure. Several of Armstrong’s board members are concerned about the possibility of the firm going into bankruptcy and have discussed with Armstrong’s chief financial officer about lowering this debt level. Uncertain of future macroeconomic performance, the planning committee has developed the following three scenarios and their effect on the company’s earnings before interest and taxes (EBIT)… ProbabilityEBIT
The company’s stock currently trades at $22.00 a share. While some within the Armstrong’s upper management want to use the company’s good reputation to issue more shares and reduce its debts, others want the company to buy back existing shares, though this would further increase the company’s debt. In any case, the company would be forced to refund all existing bondholders at par value if the company’s capital structure were modified by the exchange of debt and equity. Though the company may buy back shares, it has no plans to undertake new project requiring external funding, though some within the company (including its marketing vice president and second-largest shareholder) believe that such a cautionary stance is bad for business and that the company should either expand internally or should acquire subsidiaries, even if it means taking on further debt in order to do so. There are no specific suggestions as to what the nature of this expansion should be.
Our team has been asked by Armstrong’s chief financial officer to analyze the company’s capital structure in time for the next annual board of directors meeting, and to educate those in attendance about capital structuring through hypothetical examples. Specifically, we are to discuss…
1. …The different types of risk and how risk is measured… 2. …How debt affects risk and return to the company… 3. …The differences between on company financed with $400 million of equity, and one with $200 million...