Strategic Corporate Finance: Applications in Valuation and Capital Structure

TRENDS AND IMPLICATIONS

Many factors have complicated the task of determining an optimal capital structure: a low but rising rate environment, market volatility, increased credit complexity, more aggressive corporate financial policies, and a backlash from investors and agencies. As a result, many corporate finance executives find navigating the changing environment challenging.

Rising Interest Rates

Since January 2001, the Federal Reserve Board moved repeatedly and aggressively to lower the Fed Funds target rate, from 6.5 percent in May 2000 to a 40-year low of 1 percent in June 2003. Ten-year treasury yield fell 330 bps from 6.4 percent to 3.1 percent over the same period. Poor economic growth and employment figures during this period, as well as lagging capital markets, signaled the need for a low rate environment.

Lower interest rates and a soft equity market made debt the obvious choice for many financings in recent years. Commercial paper (CP), convertible bonds, and higher levels of floating-rate exposure have all made the cost of servicing debt appear less expensive. A steep yield curve and tight credit spreads have helped keep financing costs low, especially helpful in this period of weak operating margins.

But Fed’s actions with a measured pace of 25 bps in June and August of 2004, concurrent with rising corporate yields, suggest the bottom of the rate cycle has been tested. The economy has shown sporadic signs of improvement since the 8 percent jump in GDP growth in ...