Capital Structure Choice

Detection of optimal structure for companies at different LCO stages. Team 10

This review is focused on the detection of optimal capital structure (CS) for four Russian companies based on modern corporate finance techniques. In this study we try to determine the optimal CS for each company applying different methods, compare it with current capital structure and propose appropriate measures for management to move toward target one in case of any discrepancies. The particular interest is to apply various models (accounting and financial ones) for companies at different LCO stages, discuss the validity of each model depending on the LCO stage and compare the results for these companies. We base our analysis on historical companies financial statements over 2008-2014 since we aim at identifying optimal CS and suggest relevant recommendations for managers concerning CS policy after 2014, that is to say for the period, starting from January 1, 2015.

Entry stage: Quadra

The first analyzed company is Quadra, which specializes power generation. Together with its subsidiaries, the company generates, distributes, and sells electricity and heat energy in the Russian Federation. It operates power and heat generation facilities that are located in the regions of Belgorod, Bryansk, Voronezh, Kaluga, Kursk, Lipetsk, Orel, Ryazan, Smolensk, Tambov, and Tula. Open Joint Stock Company Quadra – Power Generation was founded in 2005 and is based in Tula, the Russian Federation.

We consider Quadra as a company at an entry LCO stage which makes it challenging to apply modern methods to detect optimal CS. Nevertheless, we employ several techniques and comment on the results.

As can be seen from the table below, Quadra financial leverage (FL) grew over the period considered which is exactly the feature of companies at entry stage as it needs huge external finance lacking internal ones to fund investments.

Graph 1. Quadra financial leverage changes over 2010-2014

[pic 1]

We try to identify the company optimal FL on the basis of several techniques. Firstly, we apply an accounting EBIT-EPS model, that provides insight to financing preferences from the investor position and company profitability considering EPS level.

The aim is to find the point where EPS is irrelevant to financing strategy as follows:

Company investing activity topped in 2012-2013 when Quadra was involved in construction of main facilities and halved in the last 2014 year.

Table 1. Quadra investing activity changes over 2009-2014, $mln

However, according to the information on the company website Quadra will undertake construction of additional power stations and wirelines that will account for nearly $80 mln. We estimate the amount needed as $117,3 mln (Capex in 2014 multiplied by the average growth rate of Capex over 2013-2014, over this period Capex decreases, we assume that in 2015 the company will require less funds as the main part of capital expenditures was already incurred). We examine company financial behavior and verify that Quadra has two options to finance this amount: via SPO at Moscow stock exchange or by taking loans from banks. In 2014 weighed average credit rate accounts for 12,15%. Current interest expense are taken from from Quadra Financial Statements for 2014. We assume the company can take loans on the same conditions in 2015. Next, we take the price for stock as at 31.12.2014 converted in dollars to calculate the additional stocks needed to finance investments by dividing the sum required on the price. We get 1’955’749,333 mln of stocks to be additionally issued.

...