Financial Case Analysis Management

Question: Describe Capital structure and Investment Decision Answer: Capital structure and investment decision making are the two important aspects of financial management. The given scenario illustrates the current position of the company and discusses the perception of the president of the firm regarding the investment opportunity (Berk and DeMarzo, 2007). Various aspects are considered in order to decision and arguments presented by the President. The company has not been performing well in the recent years. Percentage of debt is significantly high in the capital structure of the firm. In this situation, the company has been considering a new project. It has been estimated that the cost of the project will be $ 400 and the value of the project is $ 500. Hence, the net present value of the project is $ 100 and it is profitable for the company. It has been found that the total earnings of the company will enhance by $ 60 each year. Now there are two options for financing the project: debt and equity. If debt is chosen, the percentage of debt will increase and it will lead to a drop in the bond rating of the firm. Therefore, it will not be a good option (Artikis, 2007). In case of equity financing, the company will require fund of $ 400 and price of each share is $ 2. Hence, the company need around 200 shares. Earlier, the company had 1000 shares and now the total number of shares will be 1200. It has been estimated that the new earning per share will be $ 0.55 and earlier it was $ 0.60. In this situation, the president of the company has decided to postpone the project. He has argued that it will cost too high for the business to opt for debt in order to finance the new project. It is true as it will lead to high cost of capital as well as decline the bond rating (Patel and D'Souza, 2007). Additionally, the president has rightly presented the second major reason for delaying the new project. It has been found that the earning of share will decline as the market value of the equity will be less than the book value. Hence, the investors will not be interested (Berk and DeMarzo, 2007). Additionally, assessing the current market conditions it has been observed that the equity market is depressed. It is a major cause behind the lower market value of the equity. It will be a rational decision to wait for the market to improve. The president of the firm has rightly argued that the project should be delayed until the market index improves. When the equity market will be improved, the market value of the equity will be greater than the book value. Hence, the earnings per share will not decline and it will contribute in attracting the investors (Ross, Westerfield and Jaffe, 2005). Hence, it can be stated that the president of the firm has given correct logics for delaying the profitable project. References Artikis, G. (2007).Capital structure. [Bradford, England]: Emerald. Berk, J. and DeMarzo, P. (2007).Corporate finance. Boston: Pearson Addison Wesley. Patel, P. and D'Souza, R. (2007).Uncovering knowledge structures of venture capital investment decision making. [Washington, D.C.]: SBA Office of Advocacy. Ross, S., Westerfield, R. and Jaffe, J. (2005).Corporate finance. Boston: McGraw-Hill/Irwin.