Capital Structure

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UNDERSTANDING CAPITAL STRUCTURE
As discussed in the previous section, a DCF requires a discount rate. The discount rate is a function of the risk inherent in any business and industry, the degree of uncertainty regarding the projected cash flows, and the assumed capital structure. In general, discount rates vary across different businesses and industries. The greater the uncertainty about the projected cash stream, the higher the appropriate discount rate and the lower the current value of the cash streams.

STEP 6 – EXTRACT THE CAPITAL STRUCTURE FROM ANNUAL REPORT
For calculating the discount rate, we require the proportion of Equity and Debt in the capital structure using our ABC example. For the capital structure calculations, annual reports of ABC have provided us with the following information on Debt and the Equity related items from the footnotes.

The capitalization table of ABC company is as per below.
($ in MM) Short term Borrowings Revolver Bonds Of which Convertible Bonds Convertible Preferred Stock Due Date 15-Aug-09 31-May-10 31-Dec-12 31-May-10 1-Aug-12 31-Mar-14 31-Dec-10 5.2 14.2 80.0 12.0 7.0 Notes 3.2% coupon Due 5/31/2010 7.5% coupon, amortizing Bond Amortizing portion 4.5% coupon, conversion price $25, 1 bond of Fair value $100 converts into 4 shares 9.0 3% coupon, conversion price $20, 1 preferred stock of Fair value $18 converts into 1 share

UNDERSTANDING THE CAPITAL STRUCTURE OF THE FIRM
Short Term Borrowings: Short term borrowings is an account shown in the current liabilities portion of a company's balance sheet. This account is comprised of any debt incurred by a company that is due within one year. The debt in this account is usually made up of short-term bank loans taken out by a company. ABC needs to pay $5.2 million within one year along with the interest (coupon) of 3.2%.

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Revolver Revolving…...

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