Synopsis and Objectives
In July 2002, an investment banker advising Deluxe Corporation must prepare recommendations for the company’s board of directors regarding the firm’s financial policy. Some special considerations are the mix of debt and equity, maintenance of financial flexibility, and the preservation of an investment-grade bond rating. Complicating the assessment are low growth and technological obsolescence in the firm’s core business. The purpose is to recommend an appropriate financial policy for the firm and, in support of that recommendation, to show the impact on the firm’s cost of capital, financial flexibility (i.e., unused debt capacity), bond rating, and other considerations.
This case may be used to pursue a number of objectives:
* Survey the determinants of corporate bond ratings. The case highlights the important influence of the rating agencies on the costs of debt and the access to capital markets. The case data provide the opportunity to explore profitability, coverage ratios, and capitalization ratios as measures of credit quality. * Explore the practical challenges involved in determining the optimal mix of debt and equity, in particular assessing the trade-off between the benefits of debt tax shields and the costs of financial distress. The case affords the opportunity to highlight methodological problems in estimating the optimal mix. * Consider the concepts of debt capacity and financial flexibility. The notion advanced in this case is that flexibility is the ability to access capital without falling short of the firm’s minimum target credit rating.
1. What are the risks associated with Deluxe’s business and strategy? What financing requirements do you foresee for the firm in the coming years? 2. What are the main objectives of the financial policy that Rajat Singh must recommend to Deluxe Corporation’s board of directors? 3. Drawing on the...