Capital structure refers to the strategy that a company utilizes to raise capital funds and is comprised of long-term debt and equity (Gitman, 2008 p. 538). There are five potential capital structures that Competition Bikes could implement to support either merging or acquiring Canadian Bikes. To narrow these options to the one best in maximizing shareholder return, earnings per share (EPS) is analyzed. The following provides the projected earnings per share based on the moderate forecast for Canadian Bikes' earnings before interest and taxes (EBIT). .
Highlighted above are the highest earnings per share. Based on this data, it would be in the company's best interest to implement the 50% preferred stock and 50% common stock capital structure. All funds would be kept within the company, thus making it easier for the company to fund the expansion as well as maximize shareholder return. This capital structure consistently generates higher earnings per share than the alternatives, and preferred shareholders would earn $15,000 dividends each year. The next best capital structure would be the 20% bonds and 80% common stock since the earnings per share are the same for years nine and ten. Years eleven through thirteen are also very close to the EPS generated with the 50% preferred stock and 50% common stock option. The remaining capital structures have significantly lower EPS than the suggested options. More 12% bonds results in higher interest paid, especially when utilizing all 12% bonds.
Companies make financial decisions using capital budgeting using "cash inflows and outflows beyond the current year" (Hilton, 2011, p. 682). Either net present value (NPV) or internal rate of return (IRR) is used to analyze financial statements using calculations that simplify the decision making process.
Net Present Value.
Net present value utilizes a simple four-step process to determine whether or not the investment proposal should be accepted or rejected as outlined by Hilton (2011, p.