Case 7: Seattle Steel Products

Capital Structure

Case 7: Seattle Steel Products

1.

A) A firms capital structure is the mix of the company’s long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources for funds. When it comes to the capitalization of the capital structure that is when the firm is using the different sources the most efficient way possible to make the most profits.

B) The Capital Structure Theory is when the WACC is minimized, and the market value of assets are maximized, an optimal structure exists. The theory says that a firm’s value increases to a certain level of debt capital, after which it tends to remain constant and eventually begins to decrease.

2.

A) Modigliani and Miller came up with a theory which is the basis for capital structure. This theorem states that, under a certain market price process, in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in efficient market, the value of a firm is unaffected by how that firm is financed.

B) perfect and frictionless markets, no transaction costs, no default risk, no taxation, both firms and investors can borrow at the same rd interest rate.

C) Proposition I: Vu= VL is where Vu is value of unleveled firm and VL is value of levered firm. Value of levered is comprised of some mix of debt and equity. So this is simply saying that the value will be the same if levered or unleveled. Proposition II: Ke=K0+D/E(Ko-Kd) where Ke is the required rate of return, Ko is the company unleveled cost of capital, Kd is the required rate of return on borrowings, and D/E is the debt-to-equity ratio. This states that as leverage (D/E) increases, the WACC(Ko) stays constant.

D) M&M proved their propositions by graphing them. As you see WACC being constant you see everything else move up in different fashions. They have made it so it has been...