•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, i.e., you can assume that your readers would be familiar
with Modigliani and Miller (MM) theorem with corporate taxes. The report should therefore cover
material more advanced than MM with corporate taxes.
1. EXECUTIVE SUMMARY
Include a brief (half page) summary of the contents of your report and highlight its major conclusions
and recommendations.
•Half of the executive summary page should be left blank.
2. COMPANY AND INDUSTRY OVERVIEW
Provide a brief summary of the firm’s business activities and business segments and recent
developments in the company and its industry.
•This overview of up to 2 pages should also identify two comparable firms, which you will use in
your analyses in the next section. You should fully justify your choice of the comparable firms.
3. CAPITAL STRUCTURE ANALYSIS
In this section you will analyse the company’s capital structure and leverage policy.
Your discussion in this section should include but not be restricted to the following:
3.1 Historical Company Leverage/Financing Analysis and Peer/Industry Leverage
Analysis
•You should document the financing and leverage history of the company and characterise the
company’s historical (and current) leverage policy using:
o recent trends in the use of debt and equity and recent financing activities of the firm (debt and equity issues, placements and share buybacks); current and recent history of leverage and interest coverage ratios; management discussions about the firm’s leverage policy.
Does the company have a target leverage ratio?
Does the past pattern of the company’s leverage support
•the managerial inertia theory?
•the security mispricing theory?
o recent capital expenditures (including mergers) and their financing
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 and to industry average leverage (information on industry average leverages will be posted on UTSOnline).
3.2 Optimal Leverage Analysis
•You should discuss the implications of the various capital structure theories for optimal capital
structure as they apply to your assigned company including:
o Trade-off theory
The trade-off between tax benefits of debt (including personal taxes and dividend
imputation credits (see Topic 8)) and the financial distress costs
The implications of the trade-off theory determinants (see Topic 6) of optimal
leverage for the optimal leverage of the firm.
•Analyses of the determinants should be both qualitative and quantitative.
You may incorporate stakeholder theory, agency theory and predation theory (see
Topic 7) along the trade-off theory determinants mentioned above in a broader
trade-off theory framework.
The analyses of the broader trade-off theory determinants should be detailed
and should form the bulk of your analyses of optimal leverage.
o Agency theory
o Stakeholder theory
o Predation / Product market completion theory
•You should determine the optimal leverage or optimal leverage range of the firm and whether the
firm should increase, decrease or maintain its current leverage.
•You should also suggest how and when any recommended leverage change should be
implemented.
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