As you know from the theory of capital structure, some of the effects of capital structure can be easily quantified, while others cannot. In your report, you should attempt to quantify the effects as much as possible, and when necessary, qualitatively discuss the effects that cannot be quantified. The analysis of the case requires creativity on your part in finding ways to quantify the different effects and in finding the right balance between the quantitative arguments and the qualitative ones to form a sensible view of the optimal capital structure of the firm.

Also, please note that the case measures leverage using book values. When working through the case, please make sure to instead use market values. (I.e., don’t use book equity).

In your analysis, you should try to address the below points.

1. The case uses some questionable assumptions, please discuss these. E.g., the case mentions that stocks will be repurchased at $30 per share and that interest rate is 14%. Are these reasonable assumptions for all debt ratios considered in the case?
2. Briefly comment on the current capital structure policy of AHP. Does this policy appear driven by any of the theories of capital structure that we know of?
3. Evaluate the three proposed changes in capital structure. Which one is optimal?
   • Use the APV formula to analyze the different effects of capital structure on firm that can be quantified such as tax benefits & costs of distress.
   • With tax benefits, make sure to account for personal taxes & marginal investors
   • With costs of distress, try to estimate a probability of distress; you will need to make assumptions here… that’s fine, but remember to justify them
   • For other items that are not easily quantified, provide qualitative analysis
4. Be sure to test the sensitivity of your findings to the various assumptions you make

You should clearly state your choice of parameters (there are quite a few) and any assumptions you make in the course of your analysis and provide brief justification when appropriate. E.g., you will want to assume some market risk premium to conduct your analysis, and you should clearly state the risk premium you use in your calculations.

Answer rating: 100% (QA)

To address the points raised in the case and provide a comprehensive analysis of the optimal capital structure for AHP we will follow these steps 1 Qu... View the full answer