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L E A R N I N G G O A L S 506 L EVERAGE AND C APITAL S TRUCTURE C H A P T E R Across the Disciplines WHY THIS CHAPTER MATTERS TO YOU Accounting: You need to understand how to calculate and analyze operating and financial leverage and to be familiar with the tax effects of various capital structures. Information systems: You need to understand the types of cap- ital and what capital structure is, because you will provide much of the information needed in management’s determina- tion of the best capital structure for the firm. Management: You need to understand leverage so that you can magnify returns for the firm’s owners and to understand capital structure theory so that you can make decisions about the firm’s optimal capital structure. Marketing: You need to understand breakeven analysis, which you will use in pricing and product feasibility decisions. Operations: You need to understand the impact of fixed and variable operating costs on the firm’s breakeven point and its operating leverage, because these costs will have a major impact on the firm’s risk and return. Explain the optimal capital structure using a graphical view of the firm’s cost-of-capital func- tions and a zero-growth valuation model. Discuss the EBIT–EPS approach to capital structure. Review the return and risk of alternative capital structures, their linkage to market value, and other important considerations related to capital structure. LG6 LG5 LG4 Discuss the role of breakeven analysis, the oper- ating breakeven point, and the effect of changing costs on it. Understand operating, financial, and total lever- age and the relationships among them. Describe the types of capital, external assess- ment of capital structure, the capital structure of non-U.S. firms, and capital structure theory. LG3 LG2 LG1 12
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507 I n April 2000, Krispy Kreme Doughnuts went public at $21 a share. Investors gobbled up the shares as fast as con- sumers did its hot-from-the-oven glazed doughnuts. In 2001 the stock split, and the company did a secondary offering that doubled the number of shares in the market. By the end of its fiscal year in January 2002, the company’s market capitalization was over $2 billion. Krispy Kreme used the proceeds from its equity issues to fund an aggressive expansion campaign to build stores in new U.S. and international markets. Its timing was particularly good: Investors were looking for an alternative to dot-com high fliers, and the company’s popular brand and product appealed to many different types of consumers. Krispy Kreme’s financial condition was also strong. Sales growth—24 percent for the period 1998–2001 and a projected 5-year rate of over 26 percent—was well above its peers in the retail restaurant industry. Net income and EPS were beginning to climb as the company brought new stores online. Its capital structure (the mix of debt and equity used to fund the company) at October 31, 2001, consisted of $9.7 million in long-term debt and $175.8 million in stockholders’ equity. With a debt-to-equity ratio of just 5.2
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