Debt or Equity? By Professor Jonathan Welch. Characteristics of Debt and Equity Maturity Date Claim On Earnings Claim On Assets Voice In Management Investor.

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Presentation transcript:

Debt or Equity? By Professor Jonathan Welch

Characteristics of Debt and Equity Maturity Date Claim On Earnings Claim On Assets Voice In Management Investor Risk Company Risk Company Cost Yes Prior Fixed Legal Prior Impose Restrictions Low High Low Debt Common Equity No Residual Elect Directors High Low High

Financial Structure - Theory WACC MV of Debt & Equity Debt Ratio

Financial Structure Check List - Practical  Business Risk  Comparative Ratio Analysis  Ability to Service Debt – Cash Budget  Credit and Bond Rating (  EPS, P/E, Pc Impacts  Flexibility, and Future Financing  Timing  Ownership and Control  Personal Wealth Effect  Trial and Error

Average Ratios for Various Ratings of Industrial Co’s Pre-tax Interest Coverage Debt to Capital Total Debt to Equity Working Capital to L.T.D. Cash Flow to LT Debt Current ratio Pre-tax Margin ROE Pre-tax ROC Cash Flow to Cap. Expenditures % 94% 160% 199% % 17.1% 29.2% 1 8% % 114% 87% 91% % 18% 29.7% 111% % 124% 88% 49% % 14% 18.1% 111% % 129% 95% 34% % 11% 15.6% 98% AAA/AaaAA/AaA/aBBB/Baa Source: Merrill Lynch, “Fixed Income Research”