Posts Tagged ‘Debt financing’

Ralph also urged his CFO to look hard at EG’s financial structure and come up with an aggressive plan to take advantage of the tax advantages of debt financing. EG had had a policy of maintaining an AA rating from Standard & Poor’s and liked to think of itself as a strong investment-grade company. Ralph knew that many companies had taken on much higher debt levels and performed well. The performance of many had been spectacular, as managers thought harder about how to generate additional cash flow and looked more critically at investment requirements and so-called fixed expenses.
EG had sizable and stable free cash flows that could support much higher debt. The Consumerco business, which generated the bulk of the cash, was recession resistant. Ralph also knew that he did not need much reserve financial capacity given the relative maturity of EG’s core business and its limited need for capital. He also believed that EG would be able to get access to funding for a major expansion or acquisition, if it made economic sense. Otherwise, it was probably a poor investment in the first place.
By the CFO’s calculations, EG could indeed carry a lot more debt than it did, depending on the interest coverage Ralph wished to maintain. As the financial performance of the EG businesses improved, EG would be able to carry an even higher debt load comfortably. Ralph figured that at a minimum, EG could raise $500 million in new debt in the next six months and use the proceeds to repurchase shares or pay a special dividend. This debt would provide a more tax-efficient capital structure for EG, which would be worth about $200 million in present value to EG’s shareholders, assuming a combined federal and state marginal tax rate of about 40 percent.