Capital Structure

  • How does corporate borrowing increase risks to shareholders and leads to stockholders requiring higher returns?
  • I would like for you to tie/link the increase in investors perceive risk to the firm’s cost of capital in chapter 12.
  • Factors that change required returns affect firm value. Please explain this with either numerical or well-detailed written examples

Tiffany Adams and Jessica Weeks are CEO and COO of Tiff-Jess Multi-National Corporation. Tiff-Jess specializes in manufacturing solar-powered bilge pumps. The company wants to expand production. EBIT is projected to be $10,000 if the production expansion is successful. Tiff-Jess is considering whether to finance its expansion on production by selling bonds (debt) OR by issuing equity.

Tiff-Jess hires Lin Zhao & Kionte Vinson, a team of Capital Structure business consultant, to help the firm determine which capital structure option to adopt: more equity or more debt.

Upon completing some analysis on the firms’ two alternative capital structure options, Lin & Kionte were able to determine that the firm’s EBIT is greater than the indifference point. What expert advice do you think they should proffer to the management team? why?