Bed Bath & Beyond: The Capital Structure Decision Case Solution
It is expected that the company could use the debt facility at lower interest rate of 4.5% and can enjoy the tax shields while introducing debt into the capital structure of the company as it will also increase the gearing ratio, which will increase the finance risk of the company. It is expected that by using 20% debt in the capital structure of the company, it will not affect the credit rating of the company, and the gearing ratio will be at acceptable level as it will not increase the finance risk of the company because the comparable firms are using greater debt facility. However, using 20% debt facility will not increase the return on equity significantly.
Using 40% debt facility will lower the credit rating from A+ to simple A or A- and will increase the finance risk as well, however it will provide greater return to equity holders. Similarly, using the 60% and 80%debt facilitywill increase the return on equity significantly while it will lower the credit rating of the company to B and B- respectively. Using the greater debt ratio in the capital structure will also increase the finance risk of the company and investors will demand greater return.
Recommendation: The main purpose of the company is to increase the number of stores and to increase the return on equity while maintaining the credit rating of the company. The company is not facing the shortage of funds to support the future growth strategy, while using no debt in the capital structure is not satisfying the equity returns demand. Moreover, it is also competitive disadvantage for the company as it is not providing any tax shields and tax savings to the company while its competitors are using the debt facility to gain tax advantages.
Â Therefore, BBBY should also use debt in the capital structure to take the advantage of tax saving and to increase the return on equity. Using the 60% and 80% debt facility will increase the finance risk of the company and will also lower the credit rating of the company, therefore it is recommended that the firm should use 40% debt in the capital structure which will help it to achieve desired equity return along with tax savings and will also maintain the credit rating of the company as using 40% debt in the capital structure is a common practice in the industry…………….
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