Question

Company is Starbucks and data is for Year 2017

Starbucks - 2017

Capital Structure Choices (financing choice):-

-What are the different kinds or types of financing that this company has used to raise funds? i.e. How does the firm raise equity (if any)? How does the firm borrow money (if any)?

-Where do they fall in the continuum between debt and equity? Is the firm use more debt or equity in its financing structure? Discuss.

-How large, in qualitative or quantitative terms, are the advantages to this company from using debt?

-How large, in qualitative or quantitative terms, are the disadvantages to this company from using debt?

-From the qualitative trade off, does this firm look like it has too much or too little debt? Discuss.

Answer 1

1. The different types of financing that this firm used was debt and equity.

They raised equity by issuing new shares on the stock exchange. The issue of new shares incurred underwriting costs and legal issue or floatation costs. The new equity shares were fully subscribed by the public in general and thus new equity was raised.

The debt capital was issued in 2 ways: 1. The firm issues bonds to the public in general by making fixed coupon payments. These bonds could be traded on the exchange. Additionally, the company also took debt in the form of bank loans at fixed interest rate.

2. For the last calendar year, 2017, the company Starbucks had a debt/equity ratio of 0.72 . Meaning if Equity is 1, debt is 0.72

Hence total debt = 0.72/1.72 = 0.42 = 42%

Equity = 100-42 = 58%

Hence Starbucks has a healthy combination of 42% Debt and 58% Equity capital.

3. The advantages of using debt are: The interest payments on the debt are a tax deductible. Hence there is tax advantage of using debt capital. The other advantage is the debt has a lower cost of capital when compared to equity investors.

4. The disadvantages of using debt capital are that: it increases the bankruptcy costs and increases the probability of financial distress. It is never advisable to have large amounts of debt on the balance sheet. Secondly, as debt increase, the risk of the business increases and thereby the equity investors will want a higher rate of return and this is the second disadvantage.

5. The firm has just the right amount of debt. Since the Debt/equity ratio is less than 1 , it means that the debt of the firm is not acting as a disadvantage for the firm. Also the firm can take the tax advantage of debt and also not have to suffer any of the disadvantages. To conclude, the firm has a right balance between debt and equity capital.