507I
n April 2000, Krispy Kreme Doughnuts
went public at $21 a share. Investors
gobbled up the shares as fast as con-
sumers did its hot-from-the-oven glazed
doughnuts. In 2001 the stock split, and
the company did a secondary offering
that doubled the number of shares in the market. By the end of its fiscal year in January 2002, the
company’s market capitalization was over $2 billion.
Krispy Kreme used the proceeds from its equity issues to fund an aggressive expansion
campaign to build stores in new U.S. and international markets. Its timing was particularly good:
Investors were looking for an alternative to dot-com high fliers, and the company’s popular brand
and product appealed to many different types of consumers. Krispy Kreme’s financial condition
was also strong. Sales growth—24 percent for the period 1998–2001 and a projected 5-year rate
of over 26 percent—was well above its peers in the retail restaurant industry. Net income and
EPS were beginning to climb as the company brought new stores online. Its capital structure (the
mix of debt and equity used to fund the company) at October 31, 2001, consisted of $9.7 million in
long-term debt and $175.8 million in stockholders’ equity. With a debt-to-equity ratio of just 5.2
percent (extremely low compared to the industry average of 92 percent) and a times interest
earned ratio of 122, Krispy Kreme has plenty of flexibility in its capital structure.
Is a capital structure consisting mostly of equity better than one with a higher percentage
of debt? Not necessarily. Capital structure varies among companies in the same industry and
across industry groups. Within the restaurant sector, for example, you’ll findCalifornia Pizza
KitchenandCheesecake Factorywith no debt; debt-to-equity ratios of 20–30 percent atWendy’s
andApplebee’s; Papa John’sandDave & Buster’sat around 60 percent;Chart Houseand
McDonald’swith close to equal amounts of debt and equity; andAtomic Burritowith more than
twice as much debt as equity.
A company’s choice of debt versus equity depends on many factors. Conditions in the equity
markets may be unfavorable when a company needs to raise funds. When interest rates are low,
the debt markets become attractive. Before issuing debt, however, a company must be sure that
it can generate cash flows adequate to repaying its debt obligations.
Each type of long-term capital has its advantages. As we learned in Chapter 11, debt costs
less than equity. Adding debt, with its fixed rate, to the capital structure creates financial lever-
age, the use of fixed financial costs to magnify returns. Leverage also increases risk. This chapter
will show that financial leverage and capital structure are closely related concepts that can mini-
mize the cost of capital and maximize owners’ wealth.KRISPYKREME
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