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Proposing Capital Structure Change

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Let’s talk about the scenario where you are an investment banker who is willing to propose a better structure of capital to your client. So you have calibrated pro forms to preset in front of the mangers and board directors of the company Pepsi Co. Please note that it’s the expropriation of yours that will them to rely on your pro forma which is calibrated. How, if you ask?

Let’s start with the evaluation of structure of capital of Pepsi Co and their liabilities of tax for the year 2001. The balance sheet of the company reflects the marvel value as $100 billion in which $87 billion is part of equity, $354 is categorized as debt which is short-term, long term debt is entitled under $2651 along with liabilities and income taxes of %5372. Since we can notice that the debts by Pepsi Co is really little. But the question here is whether the company should take more debt or not! You must ask these questions to yourself in order to relate to the situation:

  • If the company does not take any debts, how much will they save on the income taxes of corporate?
  • Whether the company will fall into financial distress? If yes, how much likely?
  • Are the problems related to agency free flow of cash important?
  • Will the operations become smoother if they get into more debt? If yes, how much is the value of the same?
  • How will the inventors react of re purchasing the shares?

Proposing Capital Structure Change 36

Table 20.9 will help you answer most of the questions in the easiest manner. The table reflects the statistics of the company under the act of various ratings of credit, ratios of debts and coverage of interest. And well, you are smart enough to answer these questions now!

Please note that in either case, it is important for the investment banker to research about the past figures of the company. The market value of the company in the year 2001 and further and how much debt was really taken under the account of Pepsi Co will matter too. The aim is to serve the professional Pro forma which will help in developing better business and profits in the company. Generating a pro forma on a specific project can be really tricky. And companies like Pepsi Co, do not really appreciate the introduction of new products which are highly risky or incredible in terms of financial market value in the future.

But firms like start-up are always up for such projects that can help in building the brand value. And thus, creating a good pro forma also realizes a better brand value in the market. But all the predictions that you include in your spreadsheets of pro forma cannot be achieved in the future. Certain factors like selling a division to a subsidiary or uncertain events, recession declaration becomes the sensitive segments that can really affect the market value of the firm, which means your pro forma can be neglected by them easily.

And if you are expecting a gesture by your client to sit and understand your model quietly, well you are mistaken! You are talking about the company’s capital structure: a company of your client! So be ready for all the questioning and queries which might be senseless, but will be judged on your perspective of the market and your knowledge!

Preparing the model of pro forma is appreciated in the original format without introducing calibration in the same. And if you do, you must have all the answers for those changes. And yes, the judgment is too crucial on the basis of your changes on the calibration because it helps the client to judge your trust in the company! Because if you do not trust the market value of the firm, then probably others won’t!

And the project might be declined on such basis. It is not easy to propose the change in the capital structure of a company, because somewhere you question the potential and quality on the values of the firm. The discussions can be sensitive but never oppose the structure they are already following! All you need to do is suggest them changes and not declaring their structure to be wrong! The deal might close there itself! Sometimes your words speak better than your actions: Well, it is rightly said because in the world of finance, it’s only the words which are considered as your actions!

Proposing Capital Structure Change 37

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