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• 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
23.5
23.37
23
22.5
21.94
22
Share Price
21.5
20.62
21 20.27
20.5
20
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.