Maximising Stock Valuation Essay Example | Topics and Well Written Essays - 1750 words

Maximising Stock Valuation - Essay Example With this background, as per the BT management's opinion as on 31st March 1983 with the NFL loan amount of 2944 million the debt ratio for the company was too high and a new capital structure was needed to increase the stock valuation for the proposed floatation move. In the management's view the ideal capital structure should have a low level of debt which not only increases the value of the stock but also reduces the interest burden. One possible way to achieve this was to consider writing off of some portion of the debts or converting them into equity. The management also estimated that the company would have to borrow additionally to meet the cash outflow in the form of dividends, tax payments, interest charges and other necessary capital expenditure. This may increase the debt content of the capital structure which will further have negative impact on the stock valuation. Taking the argument of the management it would be ideal for the company to arrive at a capital structure where the debt equity ratio is kept at the ideal level from the point of payment of interest as well as to maintain the value of the stock. In order to achieve these objectives, the proposal by the government in converting 750 million of debts into preference shares would have been the best suggestion to follow. This can be substantiated by the following arguments that go in favour of this suggestion: 1. The calculation of the financial leverage ratio and debt equity ratio based on the projected balance sheets after incorporating the proposed conversion of debt into preference shares look as shown below: 2. In view of the lowering leverage and debt equity ratio figures the proposed Scheme of structuring of debts as suggested by the government appear to be of the optimum solution available to BT in the matter of capital structuring. 3. The proposed leverage ratio and equity ratio make the shares attractive to the shareholders since it will result in increased earnings per share. 4. Since immediately after the floatation there would be no chances for BT to go in to the equity market for making a right issue to raise funds for the capital expenditures. Even if the company had to go in for acquisitions, the company should have more cash resources to meet the acquisition cost. Such a situation can be handled only with the above proposed restructuring where the company's cash flow position improves every year with lower cost of capital. 5. Another argument that goes in favour of the proposed restructuring is that without the government converting certain portions of the loan into equity BT would be showing a 126 percent debt to equity as at the end of the year 31st March 1983 and even with the flow of retentions without the write offs the debt-equity ratio would at best be at 96 percent as the end of 31st March 1984. These levels are very high as compared to the other quoted companies. 6. Moreover the level of gearing without debt restructuring along with the interest cover of 2.8 times as existed for 1983-84 would not have made the BT's share attractive for investment. 2. As an advisor to the Government, what level of gearing would you recommend for BT and