Case Bed, Bath & Beyond

Bed Bath & Beyond

“The Capital Structure Decision”

Advanced Corporate Finance

Everaars, Tim 6160492

Groenenberg, Erik 6178944

Kruitwagen, Max 6359744

Veldkamp, Max 6270581

1. What is wrong with building up cash? Provide (at least two) reasons in favor and

against keeping cash in the firm.

You need a cash reserve for bad economic times. If business is not going very well, you’re making losses, you need some reserves to absorb these losses. If you haven’t built up any cash you won’t be able to absorb these losses and in the worst case you can go bankrupt.

When one of your customers or a company you delivered to can’t pay their bill there is a possibility you get short on cash. To be able to still purchase equipment and pay your own bills you need a cash reserve to absorb this loss without going bankrupt.

When you have cash you can invest when an opportunity comes by. This can be a favourable thing or a bad thing. When decision making is hasted or a decision is made to invest in a bad investment it is not favourable.

You pay tax twice over the cash you build up. The first time you pay tax is when you report it as income. The second time is when it is on your bank account because you pay tax every year over your company’s value. Shareholders also don’t like excess cash because the cash can be used to invest and make a profit, or can be used to repurchase shares, both leading to higher share value.

Because debt holders have more rights and bare less risk than equity holders (because they can claim goods in case of bankruptcy) it is cheaper to issue debt than keeping cash.

2. Calculate the present value of tax shield under each scenario. Assume that the

company uses a perpetual debt policy.

Scenario 1:

40% debt is $636.328.000 according to exhibit 8, to get a 20% debt to capital ratio Debt has to be $318.164.000

PV tax shield = (corp tax rate *...