Is the capital structure decisions relevant for maximizing the shareholders’ value? What is the ratio of debt-to-equity that maximizes the shareholder’s value? Why should the stockholders care about maximizing firm value? Shouldn’t they be interested in strategies that maximize shareholder value only?
What are the key drivers for increasing value of CPK how it affects its capital providers i.e. shareholders and creditors.
Modigliani-Miller theory basically states that the market value of any firm is determined by their earning power, any risk from underlying assets and its independent way of them choosing to finance their investments. So the basic idea behind this theory is that it does not make any difference whether a firm will finance itself with either debt or equity. So the way that it is applied in this case is that the value of CPK does not depend on the way the profits are divided up but on the total size of profits.
When calculating what the effect of a share repurchase will do to the firm, the calculations are shown below. Using a 10% debt to total capital structure will drive up the price of the stock up to $22.35, this will cause a 1.13% increase and will allow a possible buy back of 1,011,000 shares which is equal to a 3.47% decrease in shares. A change of 20% debt to total capital structure will move the price to $22.60, it will cause a 2.26% increase and this will help buy back 1,999,000 shares to be bought back and a 6.685 decrease. A 30% debt to total capital structure will jump the stock price to $22.86, a 2.99% increase and allow a repurchase of 2,965,000 shares, a 10.18% decrease in shares.
It is our opinion, a debt issuance to buy back shares is the best step forward for the company to do. What is recommended is for them to issue around $45,178,000 worth of debt in order to achieve a 20% debt to total capital structure. It is also recommended for CPK to use this money to buy back approximately 1,999,000 shares of their stock. This will cause an increase of 2.26% of share price which will be appeasing to their shareholders. This level is chosen because of the obvious benefit to the shareholders and because the level of risk that is involved for the shareholders is considered to be moderate. Even though if they use a 30% debt to total capital structure it will be more beneficial to shareholders, this carries too much of a risk for Collyns. By going for the most conservative 20% leverage, it will leave more room for a change in capital structure in the future, so if they want to further expand it will be possible.
The states of shares which are owned by two different sets of shareholders which is shown in the below table;