-
Analyzing a firm's capital structure
QUESTION
Analyze a firm's capital structure and its impact on firm performance. Within the assignment, explain core concepts related to business risk and recommend sound financial decisions based on analysis of a firm's capital structure and capital budgeting techniques.
| Subject | Business | Pages | 3 | Style | APA |
|---|
Answer
Analysis of a Firm’s Capital Structure
- Ways through which capital structure can influence value
The Free Cash Valuation model takes the form;
Where Vop is Value of the firm’s operations; WACC is the Weighted Average Cost of Capital, FCF is Free Cash Flow; and T is period or time.
From the above expression, it is clear that both the WACC and the FCF are crucial in validating the cash flow valuation model. This means that the effect of capital on value is influenced by WACC and FCF as the only avenues.
- 1) Business Risk and its Factors
Business risk describes the uncertainty concerning the EBIT (Earnings Before Interest and Taxes) of a firm. In other words, it is a likelihood that a firm will earn lower than anticipated or even make losses from its operations. Put simply, business risk is any condition, factor, or thing that threatens the ability of a firm to meet its financial objectives and set goals. Business risk is shaped and conditioned by various factors, with the major ones being uncertainty about demand, uncertainty about competition, variability in per-unit value and input costs, uncertainty about financial markets, and degree of operating leverage.
- 2). Operating Leverage and its Impact on Business Risk
Operating leverage refers to the resultant change in Earnings Before Interest and Taxes (EBIT) due to changes in quantity of goods sold. The operating leverage increases proportionately with an increase in the proportion of fixed cost in the overall cost structure of a firm. When the operating leverage is high, business risk increases because a small decline in sales will result in a larger reduction in the firm’s EBIT.
The operating breakeven point
The operating break-even point can be expressed as;
Where Q is the quantity sold, VC is the variable cost, P is the price per unit, and FC is fixed cost.
Reiterating the breakeven expression and inserting the provided values;
= $ 200; = $15; = $10.
Therefore,
=
= 200/5
= $40
Thus, the firm’s operating breakeven point is $40.