Team D1 Case 3

2015SP1-FIN-65151X-01 / Accounting & Finance / Professor Francois Silatchom

MODULE 3

POWERLINE NETWORK CORP.

Operating Leverage, Financial Leverage, and the Optimal Capital Structure

TEAM D1
Laura Hamin – [e-mail]
Raymond Negron – [e-mail]
Eulises Roman – [e-mail]
Myeshia Wagner – [e-mail]

Table of Contents
Executive Summary 3
Introduction 3
Analysis 4
Figure 1: Risk Comparison between Plans L and H 4
Figure 2: Operating probability under Plan L and H 5
Figure 3: Expected ROIC under plan L 5
Figure 4: Expected ROIC under plan H 6
Figure 5: Expected EBIT, NOPAT and future Cash Flows 7
Figure 6: Effects of the Financial Leverage on ROE 8
Figure 7: WACC and TIE Calculations 9
Figure 8: EPS and Stoke Price 10
Figure 9: Optimal Capital Structure 12
Conclusion 12
Case Study Data Tables 13
Table 1. Financial Statement and Other Data on Router and PNC 13
Table 2a. Operating Leverage Input 14
Table 2b. Sales Revenue Probability Distribution 14
Table 2c. Interest Rates for Router with Different Capital 15
Table 2d. Hamada Equation Inputs 15
Table 2e. Inputs Used in Financial Leverage Analysis 16
Table 2f. Important Outputs at D/V = 40% 16
References: 17

Executive Summary
The Board must seek a strategy that maximizes capital structure value. Any firm’s capital structure is a mix of debt and equity that maximizes the stock price (Brigham & Ehrhardt, 2014). Entities finance their operations through debt or its own capital. Debt can exist in many forms such as bond issues or long-term notes payable (loans, credit lines, etc.). Capital (or equity) can be stock or retained earnings. The reasons for using various financing options from each category are numerous. One of the leading factors is risk. Nobody wants risk, but without it there can be no reward. Also, it is important to weigh the value of maintaining the firm’s capital (earned interest) versus the cost of debt (interest paid) and figure in the

References: Brigham, E. F., & Ehrhardt, M. C. (2014). Financial Management: Theory & Practice . Mason, Ohio: South-Western. Guzman, O., & Media, D. (2015). Differences Between Business Risk & Financial Risk. Retrieved April 27, 2015, from Chron.com: http://smallbusiness.chron.com/differences-between-business-risk-financial-risk-100.html Investopedia. (2015). Business Risk. Retrieved April 2015, 2015, from Investopedia.com: http://www.investopedia.com/terms/b/businessrisk.asp Investopedia. (2015). Financial Leverage And Capital Structure Policy - Financial Leverage . Retrieved April 20, 2015, from Investopedia.com: http://www.investopedia.com/walkthrough/corporate-finance/5/capital-structure/financial-leverage.aspx Investopedia. (2015). Financial Risk. Retrieved April 2015, 2015, from Investopedia.com: http://www.investopedia.com/terms/f/financialrisk.asp Investopia. (2015). Operating Leverage. Retrieved April 20, 2015, from Investopia.com: http://www.investopedia.com/terms/o/operatingleverage.asp