Example research essay topic: Proposed Capital Structure For Du Pont Corporation – 1,227 words

The Du Pont Corporation was founded in 1802 to
manufacture gunpowder. After nearly two centuries
of operations, the company has greatly diversified
its product base through acquisitions and research
and development,, and is one of the largest
chemical manufacturers in the world. In 1995, Du
Pont had revenues of $42.2 billion and net income
of $3.3 billion. In this same period, 50 percent
of the company’s sales were outside the United
States. Du Pont operates in approximately 70
countries worldwide, with about 175 manufacturing
and processing facilities that include 150
chemicals and specialties plants, five petroleum
refineries, and 20 natural gas processing plants.
The company has more than 60 research and
development labs and customer service centers in
the United States, and more than 20 labs in 10
other countries. Currently, Du Pont is the
thirteenth largest U.S.

industrial/service
corporation (Fortune 500). Until the 1960’s, the
company’s capital structure had historically been
very conservative, with the corporation carrying
little debt (Figure 1). This was possible
primarily because of the enormous success of the
company. However, in the late 1960’s, competition
for Du Pont had increased considerably, and the
company experienced decreased gross margins and
return on capital Figure 1. The capital structure
of the Du Pont company from 1965 to 1982. The
company had very little debt as late as 1965, but
after the acquisition of Conoco, Du Pont changed
to a considerably more leveraged capital
structure.

During the 1970’s, three primary
variables combined to exert considerable financial
pressure on Du Pont: (i) the company embarked on a
major capital spending program designed to restore
its cost position, (ii) the rise in oil prices
increased costs and requirements for working
capital, and (iii) the recession in 1975 had a
dramatic impact on Du Pont’s fiber business. The
case analyzed in this report was written in 1982,
at which time the company had a capital structure
of approximately 36% debt (Figure 1). The company
has ambitious research plans in the future, which
require a considerable amount of externally
generated capital for 1983 through 1987 (Table 1).
Therefore, the company is seeking to develop and
stick to a capital structure, which will support
the company’s research and development interests
in these years and the decades to come. Table 1.
Financial Projections for 1983-1987, in millions
of dollars. An obvious solution for the company
would be to reduce or eliminate dividend payments.
However, the case states that this alternative is
not possible. However, if such a action were
possible, the reduction or elimination of dividend
payments would be my first choice for funding
future capital expenditures.

I believe that the
best capital structure for Du Pont is to leverage
itself to the point that it can comfortably cover
debt maintenance and other fixed costs. In so
doing, the company will gain the maximum benefit
from the resulting tax shield. This point can be
obtained by estimating cash flows in the future
using projected revenues and fixed and variable
costs, as well as the additional return required
by bondholders because of the increase in the
company’s debt. However, another variable to take
into consideration for a company like Du Pont, is
financial flexibility. Most of the company’s
products are a result of a capital-intensive
research and development program, and the company
needs to have the financial structure allowing it
to pursue positive NPV projects when the
opportunity arises. These variables suggest the
company should not lever itself to the maximum
level possible.

Another objective could be to
minimize the amount of taxes on all corporate
income, with the firm’s capital structure solely
focused on maximizing after-tax income. Personal
taxes paid by bondholders and stockholders on
income from Du Pont would be included when
calculating the company’s total tax liability.
Currently, the way the tax system in the United
States is structured, debt financing is favored.
Suggesting Du Pont should finance its future
capital expenditures only by borrowing, provided
the increase in interest demanded by the company’s
bondholders, is less than the dollars saved from
the increased tax shield provided by the debt. I
propose that the company adopt a structure with
40% debt and 60% equity, which means a slight
increase in the proportion of debt in the
company’s capital structure. Earlier, the company
prided itself on having a triple A bond rating,
which it had through 1980, when its capital
structure had a maximum of about 25% debt.
However, the company’s rating was reduced to AA in
1981, when the company borrowed additional monies,
raising debt to 39.6% of its capital structure.
The company’s management would one again like to
attain this premium bond ranking because they feel
the AAA rating is important to the company’s
image. However, in order to once again achieve
this rating, Du Pont will have to reduce the
amount of debt in its current capital structure to
at least 25%, a reduction of at least 11% (Table
2). Table 2.

Income, taxes and other data for two
proposed capital structures for the Du Pont
corporation. Data for both a 25% and 40% debt
structure are listed. I also have concerns about
the stock market’s reaction to the un-leveraging
required for the company to once again achieve
this premium bond rating. Especially considering
Du Pont’s stock is already selling for 83% of its
value. In addition, the tax shield provided by the
current amount of debt is substantial, and this
shield would be significantly lessened by reducing
the company’s debt back to 25% which gave the
company the triple A rating. In order to fund the
ambitious capital expenditures the company plans
for years 1983 through 1987, and reduce total debt
by 11%, the company would have to raise a total of
$5,444,000,000 in equity issues over five years
(Figure 2; Table 2).

Thus, I believe a financial
policy with such a reduced proportion of debt is
not in the company’s and shareholder’s best
interest. Figure 2. The total dollar value (in
millions) in equity capital that Du Pont must
raise in years 1983 through 1987 in order to meet
the necessary financing for planned capital
expenditures and reduce total debt to 25% in the
company’s capital structure. With a capital
structure of 40% debt, the company should save
approximately $ 266 million over five years from
the increased tax shield due to the additional
leverage (Figure 3, Table 2). Corporations like Du
Pont are ideal companies to carry a reasonable
amount of permanent debt because of the stability
of the company and the large amount of annual
income the company has and can thus shield from
taxes. In contrast, firms with an uncertain future
or large accumulated tax-loss carry-forwards
should probably not borrow at all.

Large, stable
corporations sometimes borrow to the point until
they start feeling significant financial distress
from the additional leverage. However, with a
organization like Du Pont, the probability of
bankruptcy is low because of the large number of
high-NPV growth opportunities inherent in a
corporation whose products are based on science.
Indeed, with my proposed capital structure (40%
debt and 60% equity), debt is actually profitable
for the shareholders (Figure 3). However, too much
financial freedom can allow managers to over
invest or indulge in an easy and glamorous
corporate lifestyle, significantly reducing
company profitability. But, considering the
success of the Du Pont company, and since it had
virtually no debt before as recently as 1960,
significant problems for the organization
associated with too much cash seem remote. Figure
3. The millions of additional tax dollars saved
over five years if Du Pont adapts a capital
structure with 40% debt and 60% equity.

In this
circumstance, with a large, stable corporation,
with several NPV-growth opportunities, debt
appears to be profitable..

Research essay sample on Proposed Capital Structure For Du Pont Corporation