ch12 - CHAPTER 12 LEVERAGE AND CAPITAL STRUCTURE LEARNING...

L E A R N I N G G O A L S
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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

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