Family Furniture Corporation: Analyzing the Effect of a Pure Capital Structure Change on the Value of a Frim

Abstract

The new CEO of a manufacturing firm is using the opportunity afforded by her recently acquired leadership role to analyze how introducing debt into the firm's capital structure might increase the value of the firm. The case leads students through an analysis of the effect of leverage on a firm's equity risk, required return, weighted average cost of capital, and ultimately, its value. The first part of the analysis involves assessing the firm's financial strength using financial ratios and valuation metrics, and evaluating whether external capital markets are likely to view the firm positively and provide debt capital at a reasonable cost. The second part of the analysis involves estimating the expected impact of debt on the firm's value and risk using both the adjusted present value and adjusted rate method. The case is deliberately framed in terms of a relatively small, family-controlled company so students can more directly relate to the strategic reasons firms pursue pure capital structure changes, a topic that can appear abstract and theoretical when taught in the context of large multinational corporations. the level of the case is appropriate for undergraduate finance majors or MBA students in a first-semester corporate finance course. Expected time to complete the case analysis is 10-14 hours of outside class time.