Introduction: Whenlooking at a company is it important to look at the balance sheets to make surethat the income is in line with the company expenses. Looking at the balancesheets will give a person a good sense of how the company is doing and if thecompany is being profitable. The next information to look at for a company isthe debt to equity. This will help the person to understand how the company isusing the equity it has and how much debt the company is using. The debt mightjust be to help minimize the amount of taxes it must pay at the end of theyear.
Introduction of company: Thepublicly traded company that will be used is John Deere. This company is one ofthe bigger businesses that sells and builds different types of tractors thatare manufactured for either residential, farmers, or construction. John Deerewas founded in 1837 and has grown over the years to become one of the most recognizablenames in the industry (Our History).
Company capital structure: JohnDeere currently has over 65 million in assets and over 25 million in long termdebt. The company also has over 14 million in short term debt. When looking atthe balance sheet for the company it looks like the company does take advantageof the interest on debts to help with taxes every year. On the income statementdated 10/29/2017 the company had interest expenses in the amount of almost$900,000 (NASDAQ.
com, n.d.). The company has a debt to equity percentage of4.17. Business risk of capital structure:Business risk ofcapital structure is when the company managers need to determine if the currentdebt of the company is still at low level of risk based on what the company isbringing in for income.
When/if thecompany managers feel that the economy or the business is not doing well the decisionwill need to be made on if some of the debt needs to be decreased to get alower risk level (Sherman, n.d.). John Deere is currentlyusing the capital structure to use the interest amounts to help with thecompany taxes. The company gets more choice control over the company when usingdebt in this way. The company has a low debt to equity ratio showing that thecompany has enough income to pay the debts that it has with no problem (Sherman,n.d.
). Managersof the company need to evaluate the company every quarter to make sure that company’sfinances are still on a good path which will allow the company to succeed. Thiscompany is doing well with managing the company finances and will need tocontinue to monitor the financial statements (Sherman, n.d.). Introduction of Modigliani and Miller theory: Modiglianiand Miller theory was developed in the 1950’s and is a theory in which thecompany is not faulted for having more debt or having more equity.
When lookingat a company to get a value, the capital structure should be irrelevant. Thevalue of the company should be done based on if there is growth potential forthe company. When a company has a higher value the value of the stock for thatcompany will be priced higher. After some time of an investor having some stockif the company does not see growth, the value of the company would drop (BENSON,n.
d.). Thereare many different assumptions that are used in this theory. The firstassumption is that there are no taxes that must be paid. The theory assumesthat the companies are in perfect capital markets, meaning that all investorshave the same information and there is not influence on price from biggerinvestors. Another assumption is that all companies have a fixed investment andhaving new investments will not affect the value of the company.
The lastassumption is that the same discount rate is applied to all stocks (BENSON, n.d.).Pros and cons of M & M theory: Onepro for this theory is it allows for businesses to be ranked based on growthregardless of what kind of business it is. This can help to show how thecompany is doing across different business categories instead of just beingranked with direct competitors.
Another pro is that it assumes that the marketsare all perfect and that the company can trade securities without cost.Investors would be more willing to invest in a company in a perfect marketbecause it could trade the security at any time without losing any money in theprocess (Investpost.org, n.d.
). Acon of this theory is that it does not take into account the business income orhow much a company has in debt. Being ranked just on how much a company couldpotential grow is not enough to get an accurate ranking on a business. A secondcon is that it does not look at the taxes the company will be charged on incomeand must pay. Taxes are a part of every business and the interest on debt is cheaperthan paying dividends. The interest on debt can be taken off on taxes but theinterest on dividends is not treated the same (Investpost.
org, n.d.). Draw conclusions of capital structure: Understandinga company’s capital structure can help investors know what company should beinvested in and what companies the investors should avoid. It helps to show howthe company is doing financially and if the company has enough assets to payback the debt it has.
A company that has a low debt ratio and has high equitywould be a good company to invest in (The Balance, n.d.). Whena company has a high debt ratio and low equity it means that the company is notdoing well and may need to look at restructuring the debt to try and make the companymore profitable. This does not mean that the company will file a bankruptcy inthe future but does mean that the company is struggling. It is also importantto take into consideration what the economy is doing when looking at a company’sbalance sheet.
Depending on if the country’s economy is on the rise or in a recessionit will affect all the businesses profit (The Balance, n.d.). Estimate company’s best capital structure: Afterlooking at John Deere’s debt to equity it is clear that this company is doingwell as managing how much debt it has. The company should continue to keep thedebt to equity below 5 or 6 to make sure it looks good to investors and that itdoes not run into any issues if there is a year that equipment sales are down. Thiscompany has good sales income but it can be hindered by the economy and howwell crops do for the farmers.
The more expensive machinery that the companysells is to the farmers and if the farmers have a bad year it could reduce theamount of equipment sold.