The Capital Structure of Nicci’s Pizza Palace
September 13, 2011

The Capital Structure of Nicci’s Pizza Palace A company is funded by debt, equity, or retained earnings. The mixture of debt and equity is the company’s capital structure. There are four factors that influence capital structure; business risk, tax position, financial flexibility, managers, growth rate, and market conditions. Management’s decisions concerning capital structure should be geared toward maximizing the intrinsic value of the company. This value is the present value of its expected future free cash flows (FCF) discounted at its weighted average cost of capital (WACC). Business risk is the basic risk of the company's operations (EBIT), excluding debt. It raises the question how well can a company’s operating income be predicted? There are several unknown variables that can assist in answering this question. The product for example, has a cost associated with its’ creation. Then there is the uncertainty of how much to charge for it, demand, operating leverage, etc. The general rule is: the greater the business risk, the lower the optimal debt ratio. Operating leverage is the use of fixed costs rather than variable costs. It is a measure of whether a company is getting value for its costs. It “can be a very powerful thing. With a cost structure geared toward a high proportion of fixed costs and few variables in the mix, strong sales almost automatically translate into higher profit growth. Companies in a position to benefit from this are typically the kind of businesses that can give you a breakeven point -- a revenue level above which the business will make a profit and where red ink goes along with sales below that mark.” (Bylund, 2011) If most of a company’s costs are fixed, and do not decline when demand falls, that company has high operating leverage, greater business risk and,