Du Pont

1. Please summary the case.

E.I. Du Pont de Nemours and Company manufactured gunpowder. As acquired with Conoco, Inc., a major oil company, Du pont grew to be the largest U.S. chemical manufacturer. The capital structure policy of the firm is extreme conservative. Because of success in product markets, Du Pont had high profits. In the late 1960s competitive conditions made the price declined and so as the sales growth and net income. Therefore, Du Pont turned to debt financing because of escalation in oil prices and recessionary conditions. Du Pont’s aim is always been to maximize financial flexibility.

There were two alternatives. The first one was to restore its historical financial strength and AAA rating. Reducing the debt ratio from 36% in 1982 to 25% by the end of 1986 would require large equity issues in each year. Another alternative was to maintain a 40% target debt ratio. This high debt policy generated higher projected EPS, dividends per share and ROE.

2. Why should a firm have a capital structure policy, i.e. a target debt ratio?

When people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which provides insight into how risky a company is. The benefits of debt financing includes that interest is tax deductable, which lowers the effective cost of debt. Debt-holders are limited to a fixed return, so stockholders do not have to share profits if the business does exceptionally well. The costs of debt financing are the agency costs.

Moreover, a good capital structure can assure the financial flexibility. Financial flexibility refers to that the firm is able to access and restructure its financing with low transaction costs. At the early year, Du Pont’s low debt policy maximized its financial flexibility and insulated its operations from financing constrains. This lowers the risk of firm when the firm are faced with the business risk and financial risk

3. Why did Du Pont abandon its AAA debt‐rating...