4. From your analysis in question 3, which capital structure proves most beneficial? By what metrics? What is your recommendation to Hill Country's CEO? Given the current corporate culture of no debt financing, what arguments will you use to covey your recommendation?

Answer 4. The ways Hill Country implement a more aggressive capital structure Hill Country Snack Food is a company that use 0% of debt and 100% of equity. Hill Country Snack Food should implement more aggressive capital structure which means they need to increase the usage of debt instead of relying only on shareholder capital. By implementing more debt, Hill Country Snack Food capital structure will decrease the financing costs and create tax shield. Tax shield is a discount in taxable income for an individual or corporation. It is attained through asserting acceptable deductions such as depreciation. Taxpayer’s taxable income will decrease because of the deduction for a given year or comply income taxes into future years.Tax shield also will reduce an individual tax payer, or a business amount of taxes owed. Therefore, by using more debt, Hill Country Snack Food also be able to reduce the usage of equity and increase the profit preserve inside the company. Hill Country Snack Food has too much liquidity because of no debt use, and the interest rate is quite low for example in Exhibit 3, with bond rating BBB the interest rate is only 4.4% so it is better if Hill Country Snack Food can involve debts in their capital structure. The effects of the change would be the increases in debt and decreases in equity. As mentioned before, Hill Country Snack Food also can get many benefit of debts such as aggressive growth strategy. 2011 RETURN ON ASSET (ROA) 10.0% RETURN ON EQUITY (ROE) 12.5% The financial performances such as ROE, ROA, EPS and dividend per share also will improves as well. For example, in Exhibit 1, the ROE improved with 12.5% in 2011. ROA for Hill Country Snack Food also improved from year 2006 until 2011 with 10% in 2011. 40% debtto-capital set the highest EPS by $3.31 compare with 20% debt-to-capital with only $3.19 and 60% debt-to-capital with only $3.11 based on Exhibit 4. Dividend per share also set the highest in 40% debt-to-capital with $0.99 refer to Exhibit 4. Conversely, most lenders offer strict penalties for missed or late payments which include charging late fees, taking ownership of collateral, or requesting the loan due early. Failure in making payments on loans for the time being can badly effect a small business’s credit rating and its capability to gain future financing. Other than that, implementing debt financing also borrowing against future earnings. This means, instead of using all future profit to pay owner or to develop the business, Country Hill Snack Food must distribute a portion to debt payments. Debt also can control future cash flow and growth, decreasing in equity could lead to higher debt-to-equity ratio. As mention earlier, debt financing involves in raising money by borrowing from a lender, with guarantee to repay the money at maturity date. It is usually come with some interest. The suitable method to increase debt financing is depend on the size and creditworthiness of the borrower. The amount of money needed as well. Debt financing can generally be divided into two which are issuing debt securities and taking out a bank loan. Example of debt securities are bonds, medium term notes and commercial paper. Bond usually have a maturity date within one year or more. Medium term notes usually have a maturity date up to 30 years. Lastly, commercial paper that have maturity date less than one year. Example of bank loans are overdraft, term loan, revolving facility and other miscellaneous forms. Overdraft is the amount borrowed that is repayable on demand. Term loan is the loan that repayable by the end of a set time. Revolving facility is the borrower can re-borrow the amount that has already paid. Lastly, other miscellaneous forms such as bill of exchange. Usually, firm can get loan from a single bank or known as a bilateral loan or a group of banks. Known as a syndicated loan. When we are issuing debt securities, an issuer can typically access a broader group of potential investors than a syndicated loan. This means, the issuer can compensate more competitive price for borrowing than with a bank loan depending on demand required at that time. Other than that, debt securities can be traded in the international capital markets because debt securities are transferable instruments and it is frequently listed on a stock exchange. So, an investor may lend their money to the issuer, but they need to oblige and wait until the maturity date for the repayment. Thus, it may give an issuer access to lend their money when a bank loan could not be possible or achievable. Next, in term interest rate, debt securities have more interest rate option for borrower because debt securities can be fixed rate, floating rate, zero coupon and so on. This are some of the advantages of issuing debt securities. Equity indicate the ownership that individuals or entities have in the company. Equity also can be translating into assets, liabilities and equity in financial terms. Cash, equipment and property that have a value is an example of assets. Liabilities re items such as debt payments that signify what a firm owns. Equity means the investment that have been made by owners. Methods could be used to increase debt and decrease equity There is some method that could be used to decrease the equity such as repurchase outstanding shares, issue dividends to shareholders, increase debt obligation, and increase expenses. Firstly, repurchase outstanding shares. When a firm repurchase share of common stock and preferred stock from investors, it uses its collected or accumulated earnings and additional capital to fund the buyback, resulting in lower shareholder’s equity. Reason why a company may repurchase outstanding shares of stock is to allocate additional capital to its shareholders. Next, issues dividends to shareholders. A firm prizes its investors by allocate a portion of its profit in the form of cash dividends. Cash dividend are shown on the company’s financial statements and known as a direct reduction of the account. This is because, since the collective earnings of a company are stated within the balance sheet equity account “retained earnings”. Equity also can be reduced by increase debt obligation. Once the liabilities are paid, the balance in shareholder’s equity signifies the legal claims of a company’s shareholders to the company’s assets. The shareholder’s equity will decrease when the company’s outstanding debt on instrument such as bonds and notes increase, the creditor entitlement on the company’s assets will increase as well. Lastly, by increases expenses also can make the equity decreases. Depreciation is an accounting method of distributed the cost of assets over its useful life. Business depreciate long term assets for tax and accounting reasons. The use of hastened depreciation method effects a higher depreciation expense during the asset’s earlier years of service. It is also effects in the lower net income and lower equity balance during that period. Arguments to persuade CEO Keener on his successor to adopt and implement our recommendation considering Hill Country’s corporate culture. Based on the Hill Country’s corporate culture, CEO Howard Keener, the company’s CEO for more than fifteen years, that he strongly believes the management’s job was to maximize shareholder value. At the end of 2011, Hill Country Snack Foods had zero debt and use 100% of equity until now for capital structure. The debt-to-capital of the company is 0%. This company has no debt, so it is the unlevered firm which means the firm that finances its operations entirely with equity. The main advantage of no debt financing in a company is that there is no obligation to repay the money earned through equity financing. The firm must plan to shift towards aggressive the capital structure by obtain the debt in low interest which can enhance the interest of shareholders as the firm can get the benefit of tax form the debt and the company does not have the problem or issue in going concern. Certainly, the CEO Keener wants it to be very successful and give investors a good return on their investment in the company, but there is no fee or interest charge required as well as debt financing. Equity financing does not provide additional financial burden to the company. It has no payment by month required with equity financing, it is doubtful the company has more capital available to invest in growing its business. This is a general statement of equity financing without debt. The absence of debt finances its actually not good for the company. Using more debt financing increases the probability that the firm will experience losses and having debt for the costs (agency and bankruptcy). It can also draw a company into a corner if they need more debt. But using debt, that company may have a better capital structure in general and moreover with tax shields, more discipline, and they can enjoy a higher return.Using the debt financing (debt) not only push up the stock price but it also brings the shareholders tax benefits. Moreover, it can support the equity holders in managing the wealth of the company more efficiency. Hill Country afraid to use the debt because, introducing the debt into the capital firm’s will be risky, but actually, the other benefit is more profitable investment opportunities. By adding debt will give a signal of strength to the market when the values rise since the shares become more attractive. The comparison Financial information for Hill Country and the competitors in year 2011 as presented in Exhibit 2, which are Snyder’s Lance, Inc and PepsiCo. PepsiCo use the debt finance which are $20,568.0 Million (49.6% of capital), but Hill Country have no debt (0% of capital). The net income of PepsiCo is $6,443.0 Million but, Hill Country just earned $97.6 Million. A firm that uses debt as a capital structure can earn higher profits than firms that do not use debt. So, it is better if Hill Country uses both capital structure (combination capital structure) is equity and debt. The costs that are owed to debt financing are reasonable, but with such costs, do not have a high impact on firm profits. Debt can be used but does not exceed the equity, and the debt cannot be used extensively as it will cause the problem of agency costs and bankruptcy. Next, the second Hill Country’s corporate culture are, the important component was a strong commitment to efficiency and controlling. To compete with competitors, it requires efficient management that can control the cost of firms. Hill Country facing off against industry giant PepsiCo and Synder's-Lance. The management try all the solution, but it is resulted unfavorable cost variance. Unfavorable cost variance means company’s profit are less than expected profit. The best solution to settle this kind of problem are to issue the debt that can provide the company with considerable tax shield as the interest expense is tax deductible. It can affect the reducing the tax payment and reduce the expenses and lastly increase the economic benefit such as increase in salary, increase in fringe benefits-leaves, insurance, and retirement, tax reduction, increase in number of jobs in department and increase in available materials within the company. The most challenges that to effective the cost controls are controlling the changes within a project in firm. While a budget has already set up, that’s will be changes will come. The rules for established business must be followed based on the type of contract of the project. How this variable effect the budget and the forecast? It will create the other problem which are insufficient resources and disconnected data and system that can impact the report. The leverage can lower the weighted cost of capital (WACC), the cost of debt lower than the cost of equity that can affect the contribute to this cost control policy. Hill Country can be more efficiently that means low cost of capital and sufficiently which means high level retained earnings or income. The final component of Hill Country’s culture and managerial philosophy was caution and risk-aversion. In the case study state that it would be unrealistic for analysts and external shareholders to expect a big change in the use of debt finance. For the safety and caution, the company would choose the 40% debt to capital because of the financial leverage for the 40% is only 1.6943 than the 60% of debt to capital which is 1.6943 of financial leverage (DFL). The higher the leverage ratio, the higher the risk level. That is the reasons why choose 40%. CEO Keener always prefer the financial safety and flexibility that when the debt include in the capital structure of the company, it can stabilize the cash outflow as the company can schedule all the interest payment that is suitable for operating and financial requirements. Lastly, it enables the management to control risk exposure. The CEO had strong preferences for equity finance and against debt finance and Hill Country was managed consistent with these beliefs.

4. From your analysis in question 3, which capital structure proves most beneficial? By what metrics?

Get Instant Homework HelpOn Your Mobile

Get Instant Homework HelpOn Your Mobile

Get Instant Homework HelpOn Your Mobile