Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate Edition
VI. Cost of Capital and
Long−Term Financial
Policy
- Financial Leverage and
Capital Structure Policy
(^620) © The McGraw−Hill
Companies, 2002
OBSERVED CAPITAL STRUCTURES
No two firms have identical capital structures. Nonetheless, there are some regular ele-
ments that we see when we start looking at actual capital structures. We discuss a few of
these next.
The most striking thing we observe about capital structures, particularly in the United
States, is that most corporations seem to have relatively low debt-equity ratios. In fact,
most corporations use much less debt financing than equity financing. To illustrate,
Table 17.7 presents median debt ratios and debt-equity ratios for various U.S. industries
classified by SIC code (we discussed such codes in Chapter 3).
In Table 17.7, what is most striking is the wide variation across industries, ranging
from essentially no debt for drug and computer companies to relatively heavy debt us-
age in the steel and department store industries. Notice that these last two industries are
the only ones for which more debt is used than equity, and most of the other industries
rely far more heavily on equity than debt. This is true even though many of the compa-
nies in these industries pay substantial taxes. Table 17.7 makes it clear that corporations
have not, in general, issued debt up to the point that tax shelters have been completely
used up, and we conclude that there must be limits to the amount of debt corporations
can use. Take a look at our nearby Work the Webbox for more on actual capital
structures.
Because different industries have different operating characteristics in terms of, for
example, EBIT volatility and asset types, there does appear to be some connection be-
tween these characteristics and capital structure. Our story involving tax savings and
CHAPTER 17 Financial Leverage and Capital Structure Policy 593
17.8
TABLE 17.7
Ratio of
Debt to Ratio of
Total Debt to Number of SIC
Industry Capital* Equity Companies Code Representative Companies
Dairy products 13.18% 15.47% 8 202 Ben and Jerry’s, Dreyer’s
Fabric apparel 23.04 29.93 38 23 VF Corp., Jones Apparel
Paper 37.09 58.99 30 26 Kimberly-Clark, Fort James
Drugs 2.75 2.83 161 283 Pfizer, Warner-Lambert
Petroleum refining 30.32 43.55 12 29 ExxonMobil, USX-Marathon
Rubber footwear 28.51 41.22 6 302 Nike, Reebok
Steel 55.84 126.46 28 331 Nucor, USX-US Steel
Computers 6.91 7.42 90 357 Cisco, Dell
Motor vehicles 41.59 71.21 39 371 Ford, General Motors
Aircraft 16.97 20.44 5 372 Boeing
Airlines 47.50 90.49 17 4512 Delta, Southwest
Cable television 39.77 68.66 8 484 Cablevision Sys, Cox Communications
Electric utilities 49.86 99.43 54 491 Southern Co., Enron
Department stores 50.53 110.43 8 531 Sears, Kohl’s
Eating places 28.31 39.49 62 5812 McDonald’s, Wendy’s
*Debt is the book value of preferred stock and long-term debt, including amounts due in one year. Equity is the market value of outstanding
shares. Total capital is the sum of debt and equity. Median values are shown.
Source: Cost of Capital, 2000 Yearbook (Chicago: Ibbotson Associates, Inc., 2000)
Capital Structures for U.S. Industries