Bixton Company’s new chief financial officer is evaluating Biston’s capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here. Rating CategoryFixed Charge CoverageFunds From Operations/Total DebtLong-Term Debt/Capitalization Aa4.00-5.25x60-80%17-23%
A.Bixton’s objective is to achieve a credit standing that falls, in the words of the chief financial officer, “comfortably within the “A” range. What target range would you recommend for each of the three credit measures?
Fixed Charge Coverage 3.00-4.30
Funds From Operations/Total Debt 45-65%
Long-Term Debt/Capitalization 22-32%
To ensure a rating that is “comfortably within the A range”, the company should try to maintain a fixed ratio of 4-4.3%, funds from operations/total debt between 60-65% and a lower long-term debt/capitalization ratio between 22-24%.
B.Before settling on these target ranges, what other factors should Bixton’s chief financial officer consider? 1.Does the company have the ability to fully utilize non-interest tax credits? 2.Does the company have the ability to raise debt from the markets? 3.Does the company have the appropriate level of income to absorb the cost associated with the issuance of the debt? 4.Does the company have the appropriate level of income to absorb the cost associated with the future fixed expense of interest payments? 5.What effect will raising debt have on consumer outlook?
C.Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve? Even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry, the chief financial officer should evaluate the current levels before deciding whether the suggested target ranges would be beneficial. For the target ranges to be effective, the company would need to be able to take full advantage of the additional tax savings generated by the additional debt and this may not be possible after evaluating the current level of R&D expenditures and the current foreign tax credit level.
Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm’s Chief financial officer would like the firm to distribute 25% of its annual earnings (POR = (0.25%) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend adjustment model, Equation (18.1), to calculate projected dividends per share for this year and the next four.
DPS1 - DPS0 = ADJ[POR(EPS1)-DPS0](FORMULA)
Formula example: 0.25*8.00-1.00*.75+1.00
A firm has 20 million common shares outstanding. It currently pays out $1.50 per share per year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary cash flow shown below in millions.
Earnings100125150120140150+ per year
Discretionary cash flow507060201550+ per year
A.Over the five-year period, what is the maximum overall payout ration the firm could achieve without triggering a securities issue?
Total earnings$635.00Formula = 100*125*150*120*140