Part I

The investment bank your group works for has been hired by the Board of Directors of the company assigned to your group to perform analyses of the company's capital structure and to provide advice on whether the current capital structure is optimal. Since your group will report directly to the Board of Directors, you can assume Financial Management level knowledge of finance.

Your group's assigned task is to produce a report on the capital structure of the company allocated to your group. In the report, you should analyse the capital structure of the assigned company following the guidelines provided below.

In your report, you must apply the theories and concepts discussed in class to the facts of the firm assigned to your group. The report should demonstrate your understanding of the theories and their practical implications.

1. COMPANY AND INDUSTRY OVERVIEW 

Visit your company's website and provide a summary of the company's business activities and business segments and recent developments in the company and its industry. Identify two comparable firms, which you will use in your analyses in the next section. You should fully justify your choice of comparable firms.

2. CAPITAL STRUCTURE ANALYSIS

A) As a publicly-traded entity, your company is required to submit half-yearly and annual reports to the Australian Securities Exchange (ASX) detailing the financial operations of the company over the past half-year or year, respectively. These reports are available on the ASX website www.asx.com.au or in the investor section of the company's own website. Go to the ASX website and search for announcements made by your company. Find the most recent annual report or half-year report and download the report. Look on the Balance Sheet to find the book value of debt and the book value of equity. If you look in the report, you should find a section which will provide a breakdown of your company's long-term debt.

B) You should document the financing and leverage history of the company and characterise the company's historical (and current) leverage policy using:

• Recent trends in the use of debt and equity and recent financing activities of the firm (debt and equity issues, placements and share buybacks);

• The current and recent history of leverage and interest coverage ratios;

• Management discussions about the firm's leverage policy.

• Is the financing behaviour of the company consistent with the Pecking Order Theory?

• You should document and discuss the firm's leverage policy relative to the leverage policies of comparable firms.

C) To estimate the cost of equity for your company, go to http://au.finance.yahoo.com plus the business section of www.smh.com.au and enter the ASX code for your company. Follow the various links to answer the following questions

• What is the most recent stock price?

• What is the market value of equity or market capitalisation?

• How many shares are outstanding?

• What is the most recent annual dividend?

• What is the beta for your company?

D) Now go back to www.bloomberg.com and find the Australian government bonds. What is the yield on government debt? Using the historical market risk premium, what is the cost of equity for your company using the Capital Asset Pricing Model (CAPM)? (Assume that the average market risk premium is 5.3%).

E) You now need to calculate the cost of debt for your company. Go to www.westpac.com.au and find the current business loan rates equivalent to each of company's debts. 

• What is the weighted average cost of debt for your company using the book-value weights?

• Does it make a difference in this case if you use book-value weights or market-value weights? 

3. OPTIMAL LEVERAGE ANALYSIS

Your group should discuss the implications of the various capital structure theories for optimal capital structure as they apply to your assigned company, including:

• Trade-off theory

• The Modigliani and Miller Propositions