Searching for an essay?

Browse the database of more than 4500 essays donated by our community members!

Proposed Capital Structure for Du Pont Corporation

The Du Pont Corporation was founded in 1802 to manufacture gunpowder. After nearly two centuries of operations, the company has greatly diversified its product base through acquisitions and research and development,, and is one of the largest chemical manufacturers in the world. In 1995, Du Pont had revenues of $42.2 billion and net income of $3.3 billion. In this same period, 50 percent of the company’s sales were outside the United States.

Du Pont operates in approximately 70 countries worldwide, with about 175 manufacturing and processing facilities that include 150 chemicals and specialties plants, five petroleum refineries, and 20 natural gas processing plants. The company has more than 60 research and development labs and customer service centers in the United States and more than 20 labs in 10 other countries. Currently, Du Pont is the thirteenth largest U.S. industrial/service corporation (Fortune 500).

Until the 1960’s, the company’s capital structure had historically been very conservative, with the corporation carrying little debt (Figure 1). This was possible primarily because of the enormous success of the company. However, in the late 1960’s, competition for Du Pont had increased considerably, and the company experienced decreased gross margins and return on capital

Writing service

Conditions

Website

essaypro

[Rated 96/100]

Prices start at $12
Min. deadline 6 hours
Writers: ESL
Refund: Yes


Payment methods: VISA, MasterCard, American Express

extraessay

[Rated 94/100]

Prices start at $11
Min. deadline 3 hours
Writers: ESL, ENL
Refund: Yes


Payment methods: VISA, MasterCard, American Express, Discover

extraessay

[Rated 92/100]

Prices start at $14
Min. deadline 8 hours
Writers: ESL, ENL
Refund: Yes


Payment methods: VISA, MasterCard, JCB, Discover

extraessay

[Rated 91/100]

Prices start at $12
Min. deadline 3 hours
Writers: ESL, ENL
Refund: Yes


Payment methods: VISA, MasterCard, JCB, Discover

Figure 1. The capital structure of the Du Pont company from 1965 to 1982. The company had very little debt as late as 1965, but after the acquisition of Conoco, Du Pont changed to a considerably more leveraged capital structure.

During the 1970’s, three primary variables combined to exert considerable financial pressure on Du Pont: (i) the company embarked on a major capital spending program designed to restore its cost position, (ii) the rise in oil prices increased costs and requirements for working capital, and (iii) the recession in 1975 had a dramatic impact on Du Pont’s fiber business.

The case analyzed in this report was written in 1982, at which time the company had a capital structure of approximately 36% debt (Figure 1). The company has ambitious research plans in the future, which require a considerable amount of externally generated capital for 1983 through 1987 (Table 1). Therefore, the company is seeking to develop and stick to a capital structure, which will support the company’s research and development interests in these years and the decades to come.

Table 1. Financial Projections for 1983-1987, in millions of dollars.

An obvious solution for the company would be to reduce or eliminate dividend payments. However, the case states that this alternative is not possible. However, if such an action were possible, the reduction or elimination of dividend payments would be my first choice for funding future capital expenditures.

I believe that the best capital structure for Du Pont is to leverage itself to the point that it can comfortably cover debt maintenance and other fixed costs. In so doing, the company will gain the maximum benefit from the resulting tax shield. This point can be obtained by estimating cash flows in the future using projected revenues and fixed and variable costs, as well as the additional return required by bondholders because of the increase in the company’s debt.

However, another variable to take into consideration for a company like Du Pont, is financial flexibility. Most of the company’s products are a result of a capital-intensive research and development program, and the company needs to have the financial structure allowing it to pursue positive NPV projects when the opportunity arises. These variables suggest the company should not lever itself to the maximum level possible.

Another objective could be to minimize the amount of taxes on all corporate income, with the firm’s capital structure solely focused on maximizing after-tax income. Personal taxes paid by bondholders and stockholders on income from Du Pont would be included when calculating the company’s total tax liability. Currently, the way the tax system in the United States is structured, debt financing is favored. Suggesting Du Pont should finance its future capital expenditures only by borrowing, provided the increase in interest demanded by the company’s bondholders, is less than the dollars saved from the increased tax shield provided by the debt.

I propose that the company adopt a structure with 40% debt and 60% equity, which means a slight increase in the proportion of debt in the company’s capital structure. Earlier, the company prided itself on having a triple-A bond rating, which it had through 1980, when its capital structure had a maximum of about 25% debt.

However, the company’s rating was reduced to AA in 1981, when the company borrowed additional monies, raising debt to 39.6% of its capital structure. The company’s management would once again like to attain this premium bond ranking because they feel the AAA rating is important to the company’s image. However, in order to once again achieve this rating, Du Pont will have to reduce the amount of debt in its current capital structure to at least 25%, a reduction of at least 11% (Table 2).

Table 2. Income, taxes and other data for two proposed capital structures for the Du Pont Corporation. Data for both a 25% and 40% debt structure are listed.

I also have concerns about the stock market’s reaction to the un-leveraging required for the company to once again achieve this premium bond rating. Especially considering Du Pont’s stock is already selling for 83% of its value. In addition, the tax shield provided by the current amount of debt is substantial, and this shield would be significantly lessened by reducing the company’s debt back to 25% which gave the company the triple-A rating.

In order to fund the ambitious capital expenditures the company plans for years 1983 through 1987, and reduce total debt by 11%, the company would have to raise a total of $5,444,000,000 in equity issues over five years (Figure 2; Table 2). Thus, I believe a financial policy with such a reduced proportion of debt is not in the company’s and shareholder’s best interest.

Figure 2. The total dollar value (in millions) in equity capital that Du Pont must raise in years 1983 through 1987 in order to meet the necessary financing for planned capital expenditures and reduce total debt to 25% in the company’s capital structure.

With a capital structure of 40% debt, the company should save approximately $ 266 million over five years from the increased tax shield due to the additional leverage (Figure 3, Table 2). Corporations like Du Pont are ideal companies to carry a reasonable amount of permanent debt because of the stability of the company and the large amount of annual income the company has and can thus shield from taxes. In contrast, firms with an uncertain future or large accumulated tax-loss carry-forwards should probably not borrow at all.

Large, stable corporations sometimes borrow to the point until they start feeling significant financial distress from the additional leverage. However, with an organization like Du Pont, the probability of bankruptcy is low because of the large number of high-NPV growth opportunities inherent in a corporation whose products are based on science. Indeed, with my proposed capital structure (40% debt and 60% equity), debt is actually profitable for the shareholders (Figure 3).

However, too much financial freedom can allow managers to over-invest or indulge in an easy and glamorous corporate lifestyle, significantly reducing company profitability. But, considering the success of the Du Pont company, and since it had virtually no debt before as recently as 1960, significant problems for the organization associated with too much cash seem remote.

Figure 3. The millions of additional tax dollars saved over five years if Du Pont adapts a capital structure with 40% debt and 60% equity. In this circumstance, with a large, stable corporation, with several NPV-growth opportunities, debt appears to be profitable.

Cite this page

Choose cite format:
Proposed Capital Structure for Du Pont Corporation. (2021, Jan 28). Retrieved September 26, 2021, from https://essayscollector.com/essays/proposed-capital-structure-for-du-pont-corporation/

Leave a Reply

Your email address will not be published. Required fields are marked *