Leveraging the Ipo

Topics: Finance, Corporate finance, Capital structure Pages: 5 (1802 words) Published: August 2, 2013
FINC615_1301A_01: Applied Managerial Finance|
Leveraging the IPO
Maureen Kelly
FINC615_1301A_01: Applied Managerial Finance
Bilal Makkawi
Colorado Technical University Online

Leveraging the IPO
Introduction
Following the discussion with managerial and finance personnel, the strategic planning head requested time to discuss the upcoming IPO. He shares that investment bankers have suggested that the organization pursue leveraging of financial opportunities to enhance the aggressiveness of Superior Living once it achieves public status. He indicates that the investment bankers feel this option will “generate millions of dollars in additional net proceeds” in connection with the IPO. The below is a summation of our conversation and includes the option of purchasing the new production plant rather than leasing the facility as well as the use of debt versus cash flow as a means of financing the project (Colorado Technical University, 2013). The Impact of Debt on a Firm’s Capital Structure

Incorrectly defining the perception of increasing debt as a benefit since the interest is a tax write-off for reducing taxable income method of choice in the area of finance. Following this reasoning, taking on more debt should optimize an organization’s standing. However, this is not always the case. An organization that increases its debt load also experiences additional cash flow reductions to offset interest expenses as they rise and lending institutions may see this as an organization’s inability to meet future financial repayment obligations (Investopedia US, 2013). Furthermore, stockholders do not see excessive debt as an optimal choice. As interest increases, EPS decreases and thus the value of stock is lower. Moreover, in a worst-case scenario, should bankruptcy happen, stockholders’ retribution is last on the list for repayment and eliminated in many instances. Therefore, a capital structure needs to combine equity and debt whiles maximizing earnings along with stock prices. Effectuation of this result is doable when the capital structure minimizes the organization’s weighted average cost of capital (the “WACC”) (Investopedia US, 2013). In the past, organizations were frugal when it came to the amount of debt incurred for self-enhancement purposes. The overall viewpoint was that capital structure correlated with the “judicious” use of debt thus increasing an organization’s value as well as shareholder wealth. Following that assessment, Kinsman and Newman (1998) performed another study, which revealed that organizations with lower debt percentages experienced higher value levels. The overall outcome of the study was suggestive of the philosophy that exaggerated debt use was in need of reevaluation. When seeking justification for debt, there are several typical reasons given. The issuance of new stock in order to meet financial needs may be costly as well effectively reducing the future earnings of current shareholders. It also serves to limit managerial control. Traditionally, organizations’ first choice for meeting financial obligations should be through a combined use of “retained earnings and debt.” The use of financing acquired through newly issued equity may project a negative impression of the market share and ultimately the standing of the organization (Kinsman, & Newman, 1998). The theory of optimal capital structure assumes that organizations are valued in an industry where the parties are all using the same information. This is not necessarily true all of the time. It is incumbent upon managers that they fully understand the organizations for which they have managerial responsibility along with the external competitive environments. This understanding must exceed all others’ levels of understanding to take advantage of their knowledge base in the most appropriate manner. Investors of an institutional nature expend much time and money in seeking this information but fall short of the...

References: Bilinski, P., & Mohamed, A. (2012, May 4). Durations between equity and debt issues and their effect on the offering announcement returns. Available at SSRN: http://ssrn.com/abstract=2054374 or http://dx.doi.org/10.2139/ssrn.2054374
Colorado Technical University. (2013). FINC615 Phase 3 activity: Long-term planning and decision-making. [M.U.S.E.]. Retrieved from Colorado Technical University Virtual Campus, FINC615-1301A-01: http://campus.ctuonline.edu
Colorado Technical University. (2013). FINC615 Phase 3 activity: Long-term planning and decision-making [Task list]. Retrieved from Colorado Technical University Virtual Campus, FINC615-1301A-01: http://campus.ctuonline.edu
Investopedia US. (2013). Corporate finance – Effects of debt on the capital structure. Retrieved from http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/debt-effects-capital-structure.asp#axzz2JvtIoXnP
Prime Revenue, Inc. (2012, November 2). Competing for success. Retrieved from http://www.primerevenue.com/blog/
PTG Media. (n.d.). Chapter 3: Financial policy. Retrieved from http://ptgmedia.pearsoncmg.com/images/0273675494/samplechapter/0273675494_ch03.PDF
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