Tesla Inc depends on debt for its expansion program. From 2013, the company's debt had grown from $598 to over $2 billion in 2015. The debt equity ratio for the company at the end of 2015 was 2.455. The ratio is within the industry average, but since the company is overvalued, debt to equity ratio is lower than established automakers. However, the ratio grew to its highest in March 2016 when it was 3.215 before declining to 1.009 in September and increasing to 1.500 in December. The figure has remained relatively constant throughout 2017.
Tesla had continued to borrow less in 2017 compared to 2015 when debts were three times owners' equity. The company currently indicates a lower risk compared to 2015 because the debt holders only have 1.5 claims over assets than equity holders (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
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Tesla has never paid any dividends to its stock holders. Similarly, the company does not intend to pay any shortly. The company has been declaring losses and therefore cannot pay any dividends. From the projected information, the company will not make any profits soon and therefore will not pay any dividends (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
The investors will not have a regular income stream from the company and might prefer investing in other businesses that pay regular dividends. However, the investors can still benefit from capital gain by selling their stocks which are overvalued. The nature of the business and the high share price might encourage potential investors to buy the shares (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
Current stockholders can benefit from selling the stock to new investors who would like to hold onto the stock in anticipation of price increase in future or possible dividend payout. However, if the company continues to experience losses, all investors might decide to sell their stocks lowering the costs in the long run and making it difficult to attract new investors (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
The capital structure of the company is ideal in that it is within the industry average. It is possible for Tesla to innovate by using borrowed funds enabling it to improve on its fleet of cars. Similarly, it is feasible to invest the borrowed funds in profitable investments allowing it to reduce the debt equity ratio in addition to paying dividends. It is cheaper to borrow funds compared to issuing shares (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
High gearing has its disadvantages especially for a company like Tesla because its inability to make profits might make it difficult for the company to meet its interest payments increase the risk of liquidation. Investors might also stop advancing additional loans to the enterprise because of its high debt to equity ratio (Arnold & Estrada, 2007).
Businesses that finance their assets using debt are riskier compared to those that use shareholders funds. Where the company is unable to pay the required liabilities when they fall due, the debtors might take over the management of the enterprise. A business that is low geared will not be affected by changes in the interest rates especially if they rise. Such companies can increase their investments and therefore generate more cash flows to invest in other projects. Companies with low debt to equity ratio are expected to regularly pay dividends which reduce the retained earnings of the enterprise (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
The relationship between capital structure, the cost of capital and risk can help the management make investment decisions. The management can use the information to invest in projects that yield higher returns than the acceptable rate which should be higher for risky projects and reflect the finance mix. The management can also select projects with positive cash flows within a given period. Where there are no projects with high rates of return, the finance should be returned to the stockholders (Parrino, 2015).
The current value of the company based on three-year historical data is $30,816,662. The value is obtained from the financial history worksheet. If the entire firm is to be sold at the moment, the shareholders can receive the above amount which is to be used to pay debt holders and the remainder shared by the shareholders according to their current shareholding (Arnold & Estrada, 2007; Parrino, 2015).
In computing the value of the firm, it is assumed that the entire company can be sold at the current price and there will be no losses or gains. Similarly, the firm can be able to get a potential investor at its present price. Additionally, it was assumed that potential future cash flows are worth more than the current price of the stock. It is also assumed that the proportion of debt is constant throughout the three years and the amount of debt is also constant. Lastly, it is assumed that there is frequent debt rebalancing and there are no taxes (Arnold & Estrada, 2007; Obeid & Sarea, 2015; Parrino, 2015).
Value of the firm using estimated cash flows = CF/(1+r)^n
From the calculation in the worksheet, the value using discounted cash flows at different rates is as follows; at five per cent the sum of the cash flow values is 273,284,262.08 obtained by discounting the projected cash flows at 5% and summing the discounted cash flows. Similarly the value at 10% is 184,534,283.41 and at 18% it is 103,808,343.77. At a lower interest rate, the cash flows are higher as opposed to when they are higher. Lower rates indicate a relatively stable business, and therefore the cash flows will be higher compared to risky investments (Arnold & Estrada, 2007; Parrino, 2015).
The economic value added as computed in the worksheet is 7577,425 for the ten years. Individual year Eva is calculated and the results added to get the sum. The computation is done by subtracting invested capital multiplied by WACC from the net income. The internal rate of return for Tesla is 8.8% while its MIRR is 100% (Arnold & Estrada, 2007; Parrino, 2015).
References
Arnold, G. and Estrada, J. (2007). Handbook of corporate finance . Harlow: Financial Times Prentice Hall.
Obeid Gharaibeh, A. and Sarea, A. (2015). The impact of capital structure and certain firm specific variables on the value of the firm: empirical evidence from Kuwait. Corporate Ownership and Control , 13(1).
Parrino, R. (2015). Corporate Finance . Singapore: John Wiley & Sons.
