To find out if Kelly Services is under performing or over performing, it is a good idea to take a look at the company's financial statements and evaluate its condition base on this. They should compare the company’s financial ratios relative to their competitors. Some of the main items used in valuing a company’s performances are: sales, earnings per share, dividends, current assets, current liabilities, and long-term debt. By using these items they can determine the company’s financial ratios to value the company’s health relative to their competitors.
A company can benefit from tax advantages by incorporating debt into its capital structure. The reason for this is that interest on debt is tax deductible on a company’s income statement. When a company issues debt in the form of bonds the interest paid is taxed only once at the personal level. On the other hand, equity has no ...view middle of the document...
When a company is all-equity financed, the distribution of earnings goes directly to the shareholders. When a company takes on debt, distributions are divided between debt-holders and equity holders, with debt-holders having priority claim. Another risk that is associated with this debt structure is the risk of default. When a company is near bankruptcy debt-holders have priority claim on the assets over the equity holders. Due to this risk, shareholder’s required rate of return increases. At low levels of debt, equity holder’s expected rate of return increases as a company increases their debt level, while debt-holders expected rate of return remains constant. When a company reaches excessive amounts of debt, debt holders expect a higher return due to a greater chance of bankruptcy. This causes expected return of equity holders to decrease because debt holders have primary claim on assets when bankruptcy occurs. Debt not only increases risk in a company but increase the variability of return on equity. As debt level increases there is more potential to have a higher return on equity. However, the appropriate capital structure lies where a company takes advantage of the tax shield while not exposing themselves to default risk.
Kelly Services believes that by repurchasing shares through debt financing the company will increase shareholders value. The debt levels that the company is considering are thirty, fifty, and seventy-percent. DMB consulting should conduct an analysis for Kelly Services at each debt level to determine if there is any value created by acquiring debt at those levels. At a debt level of thirty percent, share prices of Kelly Services will go up because debt was acquired to repurchase shares of Kelly Services. However no value will be created for shareholders, because the increase in capital gain is offset by the amount of debt used to repurchase the shares. There is no value created in the form of capital gains, but the company and shareholders can benefit from the potential of the tax shield and the possibility of a higher return on equity.