Dells capital structure Essay Example

Dells capital structure Essay During the past five years DELL Inc.s debt ratio had been increasing. Even as early as 2002, the company already had a very high debt ratio. It had a debt ratio of sixty-five percent which is way above usual benchmark amount of fifty percent. It shows that the company is heavily reliant to debt financing to support its operation. In 2004, the companys debt ratio made a shallow dip before increasing again in 2005 and 2006. The companys debt ratio increased by   five percent from 2004 to 2005. Meanwhile, there was almost a ten percent increase in the companys debt ratio from 2005 to 2006. All in all, in the past five years, the companys debt ratio has increased by almost eighteen percent. Looking at the companys debt ratio alone will lead the investor to think that the company is very high risk. The debt ratio shows that DELL Inc. more debts than assets. This means that if a liquidation should occur, there might not be sufficient assets to pay all debts of the company, much less enou gh left over for distribution to the companys stockholders.On the other hand, the companys interest coverage ratio is very good and has been steadily improving for the past four years, except for 2006. The interest coverage ratio measures the numbers of times a company earned its interest before interest and taxes. The higher the interest coverage ratio, the company can better justify its borrowings to investors and creditors. It also meant a lower debt burden for the company.   DELL managed a respectable sixty-one percent interest coverage ratio in 2002. The interest coverage ratio of the company made a radical leap in 2003 when it increased to one hundred seventy-nine percent, more than a one hundred percent increase from prior year. Another radical leap was made in 2005 when the companys interest coverage ratio increased by more than eighty percent. The companys interest coverage ratio increased more than ten percent in 2005 before making a sharp decline in 2006. For 2006, the companys interest coverage was merely one hundred sixty-four percent. The figure can be respectable for other company, but since DELL Inc. has been doing a very good job of making its debt earn profits for the company, the figure can be a warning to investors and creditors alike. The decrease in interest coverage ratio can be attributed to the ten percent increase in its debt ratio from 2005 to 2006 which led to an increase in interest expense without a corresponding increase in net income. The company manage to acquire an additional   debt increasing its interest expense by seventy-five percent in 2006 while its net income before income tax barely increased by three percent. As mentioned above, the companys interest coverage ratio for 2006 is still very good. Investors usually considers investing in a company with at   least a one and half percent interest coverage ratio and stay away from companies with less than one percent. The figure for DELL Inc. in 2006 is way beyond thes e benchmark figures.Bond ratings are based on the companys ability to pay interest periodically and the principal amount of the debt when it matures. The January 2005 edition of Business Week reported the increase of DELL Inc.s credit rating from A- to A. Standard and Poors Ratings Services gave the companys rating a boost due to several factors. These factors include DELL Incs improving market position, consistent profitability and continuous product expansion (S;P Boosts Dells Rating para. 2). The analysts also said that DELLs efficient working capital management and consistent EBITDA margin of nine percent generate strong cash flow for the company (S;P Boosts Dells Rating para. 5). A sufficient and consistent cash flow is necessary for the company to make timely interest payments. A strong cash flow means that DELL Inc. is able to pay interest payments on time as well as the principal amount of debt as they come due.   The article also praised the companys outstanding liquidity which gives it flexibility in its cash requirements despite lack of a committed credit facility (S;P Boosts Dells Rating para. 6).;Cited Work;â€Å"S;P Boost DELLs Credit Ratings.† S;P Ratings News. January 21, 2005. Business Week Online. December 13, 2006. ;http://www.businessweek.com/investor/content/jan2005/pi20050121_3300_pi036.htm;