Diagram the relationship between $ equity financing and $ bond financing for Ali
ID: 2815682 • Letter: D
Question
Diagram the relationship between $ equity financing and $ bond financing for Alibaba, Amazon, and Google. What is the relationship on average for large, Internet-based technology companies? Discuss procedure and implications.
How does a company decide among common stock, corporate bonds, and bank debt to raise needed capital?
MINI-CASE ON ALIBABA GROUP HOLDING LTD. (BABA) IS SELLING STOCK OR BONDS BEST TO RAISE CAPITAL? Headquartered in Hangzhou, China, Alibaba is an Internet-based e-commerce retailer that is twice as large as eBay and Amazon combined. Handling about half of all online transactions in China, Alibaba does in China what PayPal and Amazon do in the United States. Alibaba operates Taobao, a consumer marketplace with millions of small Chinese merchants. Recently, Alibaba acquired Silicon Valley startup company, TangoMe Inc., a mobile-messaging firm in the United States that offers popular apps used to make free video calls. TangoMe competes with WhatsApp, recently acquired by Facebok. Alibaba is also an online bank and cloud-computing firm similar to E-Trade and Google. Alibabas largest website, Taobao, has about 760 million product listings from 7 million Chinese sellers, It s free for merchants to sell products through Alibaba, but they pay Alibaba an advertising fee to gt exposure. The no-fee strategy is very popular in China. Taobao is mostly for small merchants, whereas Tmall, another shopping site owned by Alibaba, caters to large merchants. Together, Taobao and Tml account for more than half of all parcel deliveries in China. Alibaba is much more profitable thaui Amazon but has less revenues because it does not sell products Recently, Alibaba launched the largest Internet IPO by a Chinese firm in the history of the Um States and the largest IPO ever by any firm, raising $21.8 billion in its single-day IPO. Al Alibaba's Alibaba AG stock price rose 38 percent in its trading debut on the New York Stock Exchange (NYSBH broke with tradition by offering five banks equal billing to host their IPO: Credit Suisse Deutsche Bank AG, Goldman Sachs Group, P. Morgan Chase, and Morgan Stanley. Group Alibaba is growing both organically (internally) and externally through acquisitions, co diversifying into related high-tech industries. With 80 percent of China's entire e-commerceExplanation / Answer
A) The Company's quarterly Debt to Equity Ratio (D/E ratio) is Total Long Term Debt divided by total shareholder equity. It's used to help gauge a company's financial health. A higher number means the company has more debt to equity, whereas a lower number means it has less debt to equity. A D/E ratio of 1 means its debt is equivalent to its common equity.
Alibaba’s debt to equity ratio in Dec, 2017 was 0.29.Alibaba had long term debt of $18.89B and equity worth $ 65.62B. It indicates Alibaba is using equity more than debt to finance its operations.
However, rival Google’s debt to equity ratio is 0.03. It means Google is using more equity to finance its operations in comparison to Alibaba.
Amazon’s debt to equity ratio quarterly ratio in Dec, 2017 was 1.37 which indicates Amazon uses debt much more than Alibaba and google.
Google’s debt to equity ratio is ranked higher than 93% of the 199 companies in the global industry.
On an average, large internet based companies make use of more equity and bit debt for financing its operations. It indicates, Google and Alibaba are closed to industry average of debt to equity ratio. However, Amazon is using more debt which is totally opposite from industry average of debt to equity ratio.
B) A company decides among common stock, corporate bonds, and bank debt to raise needed capital through EBIT-EPS analysis.
The EBIT-EBT analysis is the method that studies the leverage, i.e. comparing alternative methods of financing at different levels of EBIT. EBIT-EPS analysis is used for making the choice of the combination and of the various sources. It helps select the alternative that yields the highest EPS.
1) Issuing bonds is much cheaper than issuing shares. When a company sells new shares, the value of its existing shares is diluted. Since shareholders take on more risk than bondholders (in the event of a bankruptcy they're further back in line to receive compensation), shareholders require a higher rate of return than do bond investors.
2) One other advantage borrowing money has over issuing shares is that it can reduce the amount of taxes a company owes. That's because the interest a company pays its lenders is counted as an expense, which means pre-tax profits are lower. Issuing shares, on the other hand, may be more expensive to shareholders, but ironically they're not classified as expenses on an income statement.
3) Borrowing money can also be riskier than the alternatives. If a company borrows too much money, or if its fortunes change and it is no longer able to pay back its lenders, it might have to raise even more capital on painful terms or go bankrupt.
The factors influencing the capital structure are discussed as follows:
1) Financial leverage of Trading on Equity: The use of long term fixed interest bearing debt and preference share capital along with equity share capital is called financial leverage or trading on equity. The use of long-term debt increases, magnifies the earnings per share if the firm yields a return higher than the cost of debt. The earnings per share also increase with the use of preference share capital but due to the fact that interest is allowed to be deducted while computing tax, the leverage impact of debt is much more. However, leverage can operate adversely also if the rate of interest on long-term loan is more than the expected rate of earnings of the firm. Therefore, it needs caution to plan the capital structure of a firm.
2) Growth in Sales: The rate of the growth in sales also affects the capital structure decision. Usually greater the rate of growth of sales, greater can be the use of debt in the financing of firm.
3) Cost of Capital: Usually, debt is a cheaper source of finance compared to preference and equity capital due to (i) fixed rate of interest on debt: (ii) legal obligation to pay interest: (iii) repayment of loan and priority in payment at the time of winding up of the company. On the other hand, the rate of dividend is not fixed on equity capital. It is not a legal obligation to pay dividend and the equity shareholders undertake the highest risk and they cannot be paid back except at the winding up of the company and that too after paying all other obligations.
4) Minimization of Risk: Financial leverage is concerned with the relationship between earnings before interest and taxes (EBIT) and earnings per share (EPS). The more fixed-cost financing i.e., debt (including financial leases) and preferred stock, a firm has in capital structure, the greater its financial risk.
5) Control: The determination of capital structure is also governed by the management desire to retain controlling hands in the company. The issue of equity share involves the risk of losing control.
6) Profitability: A capital structure should be the most profitable from the point of view of equity shareholders. Therefore, within the given constraints, maximum debt financing (which is generally cheaper) should be opted to increase the returns available to the equity shareholder.
Companies in their infancy should rely more on equity than debt. As a company grows mature, it can make use of debt securities (bonds and bank debt).
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