For this individual project you will play the role of an Investment Banker and analyze two companies in the same industry - Staples and Office Depot. You will have to make recommendations to managements of both companies in terms of optimizing their capital structure.
Assume the following for your analysis of this industry:
Expected return on Equity = 15%
Cost of Debt for companies rated Baa2 = 6%
Cost of Debt for companies rated B2 = 10%
Tax rate = 35%
All financial information (Income statement, Balance Sheet, Cash Flow Statement) for both companies is available on the respective company's website. You should use annual data for 2015 to conduct the analysis. Also, for consistency purposes use stock prices of both companies as of Dec. 31, 2015. If you have any questions or need any clarifications regarding the financial data, you should contact the company's investors relations department.
Answer the following:
1. Brief description of the two companies.
2. What are the industry dynamics?(i.e. major competitors, value drivers, opportunities, threats, etc.)
3. How has the stock of each company performed since the 2008 financial crisis - i.e. from 12/31/08 to 12/31/15.Make sure your holding period return includes dividends and is also presented in annualized form. What are the two most critical factors, in your view, for the difference in the performances?
4. Compare some key financial ratios of the two companies. Recommended ratios to include are: Current ratio, Inventory turnover, DSO, Total Assets Turnover, TIE, Debt ratio, and Net profit margin. All ratios should be computed on adjusted numbers - i.e. excluding one-time charges. What insights can you provide looking at these ratios?
5. Using the DuPont Analysis analyze the ROA and ROE generated by both companies and comment on the factors that lead to the different returns. Which company is doing a better job from a shareholder's perspective?
6. Compute the degree of operating leverage (DOL), degree of financial leverage (DFL) and the degree of total leverage (DTL) for both firms. What insights can you provide to the respective management?
7. Provide some sensitivity analysis around the revenues, operating income, and net income based on your expected operating environment. In other words, what would happen to these metrics if economic conditions turn out to be better or worse (Assume 10% variation?)
8. Based on your analysis, provide a recommendation for the optimal capital structure to managements of both companies. Your recommendations should specifically deal with the financial leverage issue - i.e. what proportion of equity and debt is optimal? Remember higher financial leverage lowers credit rating and increases the cost of capital.