Tuesday, April 30, 2013

Optimal Capital Structure and Apple.

Today Apple announced a $17 billion bond issuance to allow it to return capital to shareholders and at the same time increase the firm's leverage.    Even with this issuance, AAPL will still have a very low debt to total assets ratio of about 10% based on book values and a mere 4% based on market value.

For most firms, the optimal capital structure (i.e. the blend of debt and equity) is not zero debt.   We know this because the Trade-Off theory states that firms should trade off the benefits of debt (interest tax deductibility) against the costs of debt (mainly bankruptcy costs).  The optimal capital structure results in the highest firm value because it minimizes the firm's cost of capital.   Students of corporate finance should fully understand what is going on here  -- we discuss this in great detail in my MBA class.

Clearly AAPL has a way to go before bankruptcy costs loom, but in the meantime the positive stock price reaction observed today confirms that the firm is moving in the right direction.