Reference no: EM1336964
This problem asks you to evaluate the capital structure policies of The Clorox Company as of fiscal year-end 2007. Your goal will be to decide whether Clorox's use of debt financing is appropriate or whether, given the company's circumstances, it might prudently use more or less financial leverage.
The following questions are intended to aid your evaluation. Please address them in you answer.
(You will find information about Clorox, including its annual reports at https://www.thecloroxcompany.com.)
1. What was Clorox's shareholders' equity in 2006 and 2007? What were Clorox's liabilities-to-assets and times-interest-earned ratios in these years? What do these figures suggest about Clorox's use of financial leverage?
2. What percentage decline in EBIT could Clorox have suffered in each year before Clorox would have experienced difficulty making its interest payments out of operating income?
3. Assuming a 35 percent corporate tax rate, and 2007 earnings before interest and taxes of $856 million, by how much did Clorox's $113 million interest expense reduce taxes?
4. Answer question 1 and 2 again for 2007 assuming the company had borrowed an additional $1 billion in debt at 8 percent interest at the start of the year and distributed the proceeds to shareholders as a special dividend. You may ignore the effect of added interest expense on Clorox's balance sheet.
5. How would you assess Clorox's business risk? Setting aside the way the company is financed, how significant are the marketplace risks Clorox faces; how uncertain are the company's future operating cash flows? What does your assessment of Clorox's business risk suggest about the level of financial leverage the company can prudently support?
6. How big a threat would it be to Clorox if the company took on too much debt and had difficulty servicing it? How costly would financial distress be to Clorox? Explain.
7. Based on your analysis and any other considerations you think relevant, is Clorox heavily or modestly indebted? Should the company acquire more debt, or shed existing debt? Why?
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