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Du Pont Case Study

In: Business and Management

Submitted By sammsa
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Summary & Recommendations:
Given Du Pont’s financial history and current position, we recommend that they forego a low debt capital structure for a 40% target debt ratio and attempt to cut their dividend. In the period of 1965-1981, Du Pont had undergone drastic change in their capital structure policy. Increases in industry capacity surpassed demand growth, driving prices down. Along with inflation’s effect on required capital spending, the oil shock driving up costs, a recessionary environment for the industry, and the vertical acquisition of Conoco, Du Pont’s capital structure was near unrecognizable by the end of the transitionary period. Du Pont’s debt ratio stood at 42%, up from less than 20% and eventually led to a downgrading of the firm’s credit rating to AA. Due to
Conoco’s performance after the acquisition, the firm was in a troubled situation. Du Pont sold a part of Conoco’s assets dropping its debt ratio to 36%; Despite questionable financial ratios and poor earnings in ’82, Du Pont maintained its AA rating.
Key Issues
• The pecking order theory postulates that maintaining a 40% debt level would be ideal over the target 25% debt scenario. Reducing the debt ratio would require large issuing of equity, a source of capital that is more expensive than debt. Additionally, Du Pont’s diversified business units provide extra protection from the added-on risk of debt
• Du Pont’s shares are undervalued due to investor conceptions from previous financial performance. The Conoco acquisition, although costly and unlucky, reduces costs for Du
Pont as its vertical integration potential is still largely untapped. Issuing equity would only signal the board’s belief that the share price is accurate/over-valued, driving the price down even further. Other industry competitors are at a 40% debt level
• According to the M&M theorem, Du Pont’s value as a…...

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