Capital Structure a Company's Capital Structure Is Essay

Capital Structure

A company's capital structure is the balance of different methods of financing that provides funding for the company's operations. The basic breakdown is between debt and equity, but preferred shares may also factor into the capital structure. Debt includes all forms of liabilities, including both long-term debt and current liabilities. Equity includes both the book value of shares issued and the company's retained earnings. The market value of the shares is not relevant in calculating the firm's capital structure. Analyzing the capital structure of the company is done by first calculating the capital structure. Because debt and equity have different risk characteristics, the ideal capital structure of the company must be evaluated against the type of business model that it has. Different risk profiles (capital structure) are considered ideal for different types of companies. This report will analyze the capital structures of three companies -- Goodyear (NYSE: GT), Campbell Soup (NYSE: CPB) and Hewlett-Packard (NYSE: HPQ) and provide conclusions with respect to the fit of each company's capital structure in relation to its theoretical ideal capital structure.

Goodyear Rubber and Tire Co.

The current capital structure for Goodyear is 91.6% debt and 8.4% equity (MSN Moneycentral, 2011). The company has maintained a similar capital structure for the past several years. As recently as 2006, Goodyear had negative equity, so it has a long history of being highly leveraged. Leverage increases the risk associated with owning the company's equity, since a large portion of the firm's free cash flow must be dedicated to debt service, which typically has priority over disbursement to shareholders. This also reduces the amount of money that the company can put towards expansion. This can place limits on growth and on the ability of the company to pursue competitive opportunities that might arise.

Goodyear's business is mature. The company operates in the consumer goods sector, and has been in business for decades.The core businesses -- tires and rubber -- are generally mature. The former depends heavily on the market for automobiles, which is generally mature in the United States. Goodyear's revenues over the past five years confirm that it operates in a mature industry -- revenues for 2010 were just 0.4% higher than revenues for 2006. The company in that time has not made any substantial acquisitions or divestitures that would have altered the size and shape of the company. Only once in the past five years has Goodyear recorded a positive net income, which again indicates that the market is either mature or perhaps even on the decline.

The optimal capital structure for Goodyear can be high on debt, for two reasons. The first is that the company does not need the funds for expansion. The second is that debt has a lower cost than does equity. The firm's weighted-average cost of capital, therefore, will be lower if it has a higher proportion of debt in its capital structure. However, the current capital structure of Goodyear is too high. The bare minimum of equity that the company currently has in its capital structure is more indicative of its lack of profitability than anything else. While increasing equity would increase the cost of capital, it would also be a sign that the company has found a way to put some retained earnings into the business.

Campbell Soup

As with Goodyear, Campbell Soup operates in the consumer products sector. Its business is mature, as evidenced by its annual revenues, which have been stable in the $7.385 - $7.998 billion range for the past five years (MSN Moneycentral, 2011). The firm's profits are also stable, three times in five years landing in the $800 million range. As with Goodyear, the maturity of the Campbell Soup business makes it a good candidate for a higher degree of leverage. It does.....