This chapter provides an overview of the effects of leverage and describes the process that firms use to determine their optimal capital structure. The chapter also indicates that capital structures tend to vary across industries and across countries. If you are interested in exploring these differences in more detail, the Morningstar website provides information about the capital structures of each of the companies it follows. The following discussion questions demonstrate how we can use this information to evaluate the capital structures for four restaurant companies: Cheesecake Factory (CAKE), Chipotle Mexican Grill (CMG), BJ’s Restaurants Inc. (BJRI), and Darden Restaurants Inc. (DRI).

Questions

1. To get an overall picture of each company’s capital structure, it is helpful to look at the Key Ratios screen by selecting Full Key Ratios Data and then selecting the Financial Health tab. Common size balance sheet data are provided over a 10-year period. What, if any, are the major trends that emerge when you’re looking at these data? Do these companies tend to have relatively high or relatively low levels of debt? Do these companies have significant levels of current liabilities? Have their capital structures changed over time?
2. Repeat this procedure for the other three companies. Do you find similar capital structures for each of the four companies? Do you find that the capital structures have moved in the same direction over the past 5 years, or have the different companies changed their capital structures in different ways over the past 5 years?
3. The financial ratios investigated thus far are based on book values of debt and equity. Determine whether using the market value of equity makes a significant difference in the firm’s capital structure. To make these calculations, you will have to use the balance sheet information (5 years of data are shown) provided in the Financials screen by screening down to the Balance Sheet section, clicking on Balance Sheet, and selecting More Financials Detail Data and moving the bottom bar to the right so the last 5 years of data can be seen. The market capitalization data are provided in the Quote tab. Once you have these data, you can recalculate the market percentages of debt and equity in the firm’s capital structure. (Here, we assume that the book and market values of the firm’s debt are the same.) Are there big differences between the capital structures measured on a book or market basis? Explain your answer.