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Essay / Dupont Affair - 1919
SummaryDuPont is known for its low dependence on loans. In the 1970s, the company had to assume a significant portion of the debt of Conoco, a newly acquired company. In 1983, leaders must decide on the optimal future debt ratio. Should the company continue to maintain approximately 40% of its assets financed by debt or should it work to reduce its borrowing to 25%? We have defined several criteria to determine our choice: yield, risks and other quantitative and qualitative factors. Targeting a debt ratio of 40% will maximize the value of the company. Higher earnings per share and dividends per share will cause the stock price to rise in the future. Through leverage, the return on equity is higher because debt is the primary source of funding for capital expenditures. To maintain the debt ratio of 40%, no equity issues will be declared before 1985. DuPont will finance the necessary funds through debt. From 1986, minimum equity funds will be issued. It will be timed to take advantage of favorable market conditions. The remainder of the necessary financing will be acquired through the issuance of debt securities.Case BackgroundDuPont is a very large company with a low debt policy designed to maximize financial flexibility and insulate operations from financial constraints. It is one of the few AAA-rated manufacturing companies because its investments are primarily financed from internal sources. However, as prices fell in the 1960s, DuPont's net profit also declined. Unfavorable economic conditions in the 1970s increased inflation: rising oil prices increased the inventory investments required by the business. The 1975 recession had a 33% negative impact on DuPont's net income and both return on capital and earnings per share fell. The company cut its dividends in 1974 and its working capital investments were eliminated. The proportion of debt increased from 7% in 1972 to 27% in 1975 and interest coverage fell from 38 to 4.6. The company saw a temporary increase in debt, but moved quickly to reduce its debt ratio by reducing capital expenditures. The proportion of debt fell to 20%, interest coverage increased to 11.5 in 1979. In 1981, DuPont issued $3.9 billion in common stock, $3.85 billion in debt and assumed $1.9 billion of Conoco debt to acquire Conoco. DuPont's debt ratio increases to 42%, interest coverage to 5.5 and ratings are down to AA. In 1982, the merger with Conoco produced poor results. DuPont also lowered its debt ratio to 36% through asset sales, but interest coverage was reduced to 4.