3)Attempting to remedy the situation, the firm cut its dividend in 1974 and 1975 and drastically reduced its working capital investment they turned to debt financing. Du Pont's debt-to-equity ratio rose from a conservative 7% in 1972 to 27% in 1975 while the interest coverage ratio fell from 38 to 4.6. The increased debt ratio shows that they were moving towards a higher leveraged position and aggressively financing growth with debt. The reduced interest coverage indicates that Du Pont was now more likely to be unable to meet the required interest payments on its debt.
Even with these financial risks, the company's size, diversity, and history as a leader in manufacturing allowed it ...view middle of the document...
We use this as a basis for comparing the two alternatives.
|CURRENT |1982 |
|DEBT | |
|cost of debt |12.27% |
|after-tax cost of debt |7.36% |
|debt ratio |35.7 |
|weighted cost of debt |2.628234 |
| | |
| | |
|EQUITY |7% |
|market price/share |37.19 |
|dividends |2.4 |
|div/price |0.064533477 |
|growth |1% |
|cost of equity |7.45% |
|propotion equity |64.3 |
|weighted cost of equity |4.792502554 |
| | |
|WEIGHTED AVERAGE COST OF | |
|CAPITAL |7.42% |
We then compute for the weighted average cost of capital for the corresponding alternatives in order to determine the capital structure that maximizes the value of the firm.
|40% DEBT |1983 |1984 |1985 |1986 |1987 |
|DEBT | | | | | |
|after-tax cost of debt |8.71% |8.71% |8.71% |8.71% |8.71% |
|debt ratio |36.00 |37.1 |39.7 |40 |40 |
|weighted cost of debt |3.14 |3.23 |3.46 |3.48 |3.48 |
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