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Optimal Capital Structure

for Tonka Corporation


Company Overview
Fifth largest company in the United States
Industry Toys and games
Founded Mound, Minnesota, 
United States (1946)
Founder Lynn Everett Bake,
Avery F. Crounse,
Alvin F. Tesch
Parent Hasbro (1991–present)
Funrise Toys (2011-
present)
Objectives
 To find out the optimal capital structure of 
corporation
 To determine whether the company could use 
financial resources more effectively
PESTEL Analysis

Political Economic  Social

• External Stakeholders  • Efficiency of financial  • Societal norms and 


• Political stability in the  markets hierarchy 
existing markets  • Inflation rate • Attitude towards health 
• Governance System • Downward pressure on  and safety
• Regulatory Practices consumer spending • Access to essential 
• Economic Cycles services
• Power structure
PESTEL Analysis

Technological Environmental Legal


• Lowering cost of  • Renewable technology • Business Laws
production • Waste management • Data protection laws
• Intellectual property rights  • Regular scrutiny by  • Protection of Copy 
and patents protection environmental agencies
• Mobile Technology rights & patent
• Environmental norms 
• Technology based  • Employment Law
altering the priorities of 
innovation product innovation
Porter’s Five Forces Model
• Barriers to entry
Threat of New  • High capital requirement for producing toys
Entrants • Customer loyalty

• Reduction of quality in customized toys
Threat of  • Switching cost of buyer
Substitutes • Close substitution are available

Bargaining  • Buyer price sensitivity
Power of  • Bargaining leverage
• Competitive advantage of company’s product
Buyers
Porter’s Five Forces Model

Bargaining  • Input differentiation
Power of  • Impact of cost on differentiation
Suppliers • Strength of distribution centers

• Competitive advantage
Degree of 
• Continuous innovation
Industry 
• Level of advertising
Rivalry
Company Analysis
350

300 293.4
250
244.4
200

  Sales

150 139
100

  81.1 87.8

50
0
1982 1983 1984 1985 1986

Year 1982 1983 1984 1985 1986


Sales (In
81.1 87.8 139.0 244.4 293.4
ml.$)
Company Analysis
Share Price
24

23.5
23.37
23

22.5
21.94
22
Share Price
21.5
20.62
21 20.27

20.5

20

19.5 14.3% 20% 40% 60%


Ratio Analysis
Current Ratio
Year 1985 1986
C/R 1.66 2.52

Quick Ratio
Year 1985 1986
Quick Ratio 1.25 2.42

Return on Assets
Year 1985 1986
ROA 15% 14%
Risk Analysis
• Leverage cost of equity: 19.532%
• Unlevered cost of Equity: 18.86%
Financial risk for different D/E ratios
positive correlation exists between risk and D/E ratio
D/E (Book) D/D+E (Market) D/E (Market) βe βe - βo
0% 0% 0% 1% 0%
20% 13% 14.90% 1.124 0.085
40% 24.40% 32.30% 1.224 0.185
60% 34.70% 53.20% 1.343 0.304
MM Proposition with Taxes
Assuming MM Model with taxes
VL = EBIT (1-TC)/R0 + D*TC
Actual 20% 40% 60%
EBIT (mil $) 44.10
Ro 18.86%
Tax 45%
Debt (mil) 16.70 22.70 45.20 67.80
Vu 128.59
Vl 136.10 138.80 148.90 159.10
Value added 2.70 12.83 23.00

 Value of Tonka Corporation rises with the increase of debt in its capital structure
Sensitivity Test
Changes in Earnings per share (EPS)
ΔEPS Recession Expected Expansion
20% Debt -4% 0% 1%
40% Debt -20% 3% 6%
60% Debt -40% 7% 13%
Changes in Return on Equity
ΔROE Recession Expected Expansion
20% Debt -3% 2% 3%
40% Debt -13% 10% 15%
60% Debt -31% 22% 29%
Sensitivity Test
D/E (Book) D/E (Market) Share prices
0% 0% 20.27
20% 13.00% 20.62
40% 24.40% 21.94
60% 34.70% 23.27
Conclusions
 Though value of Tonka Corporation is maximized on using 60% of debt in its 
capital structure 
 Due to high risk involved in unfavorable condition and the shareholders of 
Tonka Corporation are assumed to be risk averse
 Use of 40% debt in the capital structure is suggested to be the desired and 
optimum  capital  structure  for  Tonka  Corporation  where  it  can  have 
maximum  profitability,  minimum  risk,  and  reduction  of  the  risk  of  hostile 
takeover.
 Issuing debt will give a signal to the market that the company is doing well 
and is expecting to have good results.

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