Paper Sample on Maximizing Shareholders Wealth: The Benefits of a Good Capital Structure and Financing Strategy

Introduction

Any company must be able to manage its capital structure and financing. A good capital structure and financing strategy enable the management not only to increase the value of the firm but also to increase the profits of the firm. The administration will be able to achieve the significant goal of maximizing the shareholders' wealth (Baran et al., 2016). For example, a firm that prefers to apply a strategy that is composed of more debt capital than equity capital will be able to minimize the cost of capital, thus increasing the shareholder's wealth. Above all, the company needs to have a plan that protects it from financial risks while maintaining the company's flexibility to expand.

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Tesla Inc

Tesla Inc. is an automobile and energy company that was the first company to manufacture electric cars. Elsa produces eco-friendly vehicles that are also quite powerful. The fact that its consumers no longer have to visit gas stations when refilling their vehicles but instead they only have to recharge their vehicles has helped Elsa Inc. experience notable growth since they launched this product. According to Forbes, with a valuation of $208 billion, the company is the most valuable car manufacture in the world. However, the company's financial position is not precarious as it is focused on expansion and more intense investments. Thereby, the management might be risking bankruptcy in the future if it is stuck in massive debts.

Tesla's capital structure and financing have raised a debate on the company's ability to remain relevant in the industry. Financial analysts and investors may not be wrong for thinking that the company is in a severe economic crisis. In the year 2013, the price of Tesla's stock price took a dramatic rise from a previous average of $30 to a new high of $190.90. In the following years, the cost of their stock share continued to inflate to $250 in 2016. In 2017 the company sold its shares at a record of $340. The high increase in the price of Tesla’s stock resembled that of technology companies like Apple Inc., which have experienced such growth rates in the past. However, by the end of 2019, the price of the stock was slightly above $200. Although the company has impressive records, it may have some severe capital budgeting and financing structure issues.

In 2020 the company has been able to increase its gross revenues substantially by more than one million dollars compared to the sales of the previous quarter. As a result, Tesla has successfully expanded its total gross profit margins compared to previous records. The high increase in revenues was a result of adjustments in the company's pricing models. Compared to previous financial years, the cash flow balances have also experienced some growth. However, the company's liquidity ratio is relatively weak, raising questions on its ability to raise cash in the future (Wall, 2019).

Current Ratio

The current ratio measures the ability of a firm to recompense its short term obligations. The company has maintained its current ratio at 1.1x until in the last quarter was it increased to 1.2x. Tesla's quick ratio is an average of 0.78 over the previous three quarters. However, it has grown to 0.87 in July 2020, an indication that the company is in a better position to pay for its short term debt using the available liquid assets.

Tesla Company has been making net losses for the last three years. Telsa's net margin for the previous quarter in May 2020 was 0.27 %. This is after it had a net income of $16 and total revenue of $5,985 for the first quarter of 2020 (Table 1.2). However, the management has managed to maintain a positive cash return to revenue ratio. They have maintained a positive cash return to revenue ratio by closing their financial statements with big cash at hand and bank balances.

Tesla Debt to Equity Ratio

Debt to Equity Ratio is a good measure of how a company gets the funds for its operations. Financial advisors would recommend a balanced debt to equity ratio of one that balances the debt funds and equity funds. However, various factors in the market, like the cost of debt due to high-interest rates, affect the liability to equity structure, and managers apply ratios that they see fit for their firms (Mehta & Bhavani, 2018). In order to define Tesla’s debt ratio, it is essential to differentiate between the different debts. The debt includes the company’s total debt, the long term loans, and the total liabilities. On top of Tesla’s debts are leases, which include the interest to be paid in the future. Besides the rentals, the company has to clear the accounts payable and other short term and long term loans.

The total debt to equity ratio of Tesla was 1.5 in the first quarter of 2020 after dropping from 2.0 in the previous year. A lower debt to equity ratio indicates that the company has balanced between equity and its total indebtedness. It is also an indication that the management preferred to issues more shares as a way of raising funds instead of using more debt. The strategy of getting capital funds through equity is less risky. However, it reduces the company’s power in making significant decisions. Similarly, Tesla’s total liabilities to equity ratio has since decreased in the first quarter of 2020 to 2.5. The decrease is a significant one because in the previous quarter the ratio was at 4.3., Tesla lowest in the past five years.

Although the company’s total debt is still increasing, it is more inclined towards equity funds rather than debt. However, the majority of the company’s assets are still funded by debt. About three-quarters of the total assets are financed through debt even after the total debt to equity ratio has reduced. Tesla is a high-risk company determined to grow in the young industry of electric car production.

Qualitative Research

Tesla Growth Strategy

The management of Tesla is more than determined to make sure that the company thrives in the new industry of electric cars. Of course, the manufacturing of electric vehicles is still a young industry, nonetheless up-and-coming. Firstly all-electric cars have zero emissions thus ecofriendly. Secondly, they are more flexible to use as the consumers are now spared from visiting petrol stations. All they need to do is charge the cars before going for a ride. The company's strategy when it launched its first car was more of a skimming plan because the first car was rather expensive. The fact that the company had no economies of scale is a contributing factor as to why they chose this strategy.

Tesla's strategy of growth strategy involves a more direct approach to selling by dominating their sales channels all over the world. The company's management is determined to invest in creating pathways directly connected to Tesla. For example, they have built showrooms and service centers in more than 400 different places in the world before the beginning of 2020. The provision of Tesla service centers boosts their sales as the consumers are serviced directly by the company's technicians. The company has also invested in technologies that allow technicians to fix some issues online. A good example is the Model S, an SUV produced by Tesla that can upload data online, allowing Tesla's technicians to adjust it from a distance.

Besides the services stations, Tesla needs to provide its consumers with Supercharger stations. These stations can be compared to gas stations as they are responsible for providing the cars with a source of electric power. Tesla allows its drivers to charge their vehicles on these supercharge stations for free. It is essential to have supercharged stations as drivers are at times faced with the challenge of not having enough power while traveling. The provision of Supercharge stations will increase the adoption of electric cars to the general population. Therefore, Tesla is justified in investing in the construction of Supercharge stations in the USA, Europe, and Asia.

Tesla's Big Projects

Tesla is determined to make more Gigafactories to facilitate the production of Tesla's products and energy. The factories not only increase the rate of production of electric cars but also make the process of manufacturing the cars more accessible. The Nevada station was the first of these factories, and it is currently the largest in the world. Tesla has opened other gigafactories in New York in 2017and Shanghai, Asia, in 2020. As if that is not enough, the company plans to open more factories in Europe, Asia, Central U.S., and Berlin. These projects are capital intensive but are essential for the growth of Tesla. However, the investments in these factories may affect Tesla when the market is big enough to accommodate other players.

The improved model of Roadster and the Cybertruck is Tesla's groundbreaking models expected to be released in 2021. Roadster 2.0 model is expected to be the fastest car in the world, as announced by Tesla CEO Elon Musk. Cybertruck is already very popular and is expected to have a lot of sales. The two models will not only make money for Tesla but will also signify Tesla's ability to bring change in the world of innovation. As a result, more investors will have more faith in the company's power in delivery. Therefore, the company will not only attract more investors but also gain the support of the consumers.

Automotive Industry Financial Research

The automotive industry is not only capital intensive but also labor-intensive. The companies need a lot of money to cater to the expenses, which range from raw materials, equipment and machinery, building, parts to be assembled, and labor. Generally, sales in the automotive industry are affected by various factors like seasons and the cost of fuel (Ferro, 2015). Therefore, companies in the automotive industry need to have the right capital management strategies to cater for the costs and expenses even when the sales are low. Labor is quite expensive in the United States compared to Asia. Therefore, automotive industries in Asia have a comparative advantage over their counterparts in Europe and the USA.

The high cost of labor in the USA and Europe increases the total costs and expenses of the industries in these locations. As a result, companies like Tesla and Ford depend on debt to finance their operations. General Motors’ (GM) has a relatively lower debt to capital ratio of 45.6%. The ration means that the company operates with less debt, and it can even increase its debt in case it needs more finances for expansion. Ford (F) has a higher debt to capital ratio of 81%. The debt to capital ratio of Tesla is also high at 76%. As evident, Asian automotive companies have lower debt to capital ratio compared to those based in the USA and Europe. On the one hand, Honda, Nissan, and Toyota have rates that are below the industry’s average debt to capital ratio of 54.1%. On the other hand, are Daimler, Tesla, and BMW, whose net debt-to-EBITDA are very high.

Conclusion

The electric vehicle industry is growing at a high rate due to the regulations by governments requiring automotive industries to conserve the environment. The use of electricity as a source of energy in cars also makes sure that gas oil is used more efficiently globally. In the near future, the demand for electric cars is predicted to increase further.