By Alastair Graham
Themes comprise: investment concepts on hand to managers * fairness investment * debt investment * hybrid monetary tools * types at the optimum capital constitution * debt profile administration * refinancing.
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Additional info for Capital Structuring (Glenlake Risk Management)
5 times. An interest cover covenant makes it an event of default for the borrower’s profit before tax and interest (PBIT) to fall below the stipulated multiple of interest payments. Example 2 The risks of taking on excessive debt even for a profitable company were clear in the case of Autos Inc, a small listed used-car dealer. In the first half of 1997, the company announced interim profits that had increased over the previous years. At the time book leverage (sheet debt/stockholders’ funds) stood at 175% but interest cover was three times, that was seen to be in line with projections.
However, lower demand for used vehicles and a subsequent decline in both sales and margins in the second half led to a profit warning in July 1998 that indicated a loss, thus wiping out interest cover. As a result, the company’s stock price fell 37% in the week following the warning, further increasing the company’s leverage. A business review identified a need to reduce the break-even point of the business, and to restructure its external financing through an injection of additional equity. A prudent financial manager will set the debt component of the company’s capital structure at a level that can be serviced in the worst case event of a fall in profits and a rise in interest rates.
E. e. to changes in the prices of the company’s products ● the risk of government intervention or legislation affecting the company’s business. It was explained earlier that a high financial leverage level exposes a company’s stockholders to the risk of volatile earnings. This risk will be much higher when the company is exposed to significant commercial risks. Operational Leverage Commercial risk can be particularly high in companies with high operating leverage. Operating leverage refers to the cost structure of a company’s operations, and the way in which income changes with an increase or decrease in sales.