The purpose of this paper is to analyze Ford Motor Companys capital structure to understand the financial risks and companies financial make up. The research paper will also discuss the Modigliani and Miller capital structure theory including common criticisms. To understand Fords profitability we will take a close look at their financial ratios including stock rates and future analysis of the companys assets. Research was done by reading news articles, online periodicals and stock references including Fords own annual reports and website. In conclusions we will understand the optimal structure for Ford Motor Company and what should be done to ensure continued success within an ever changing industry.
Overview of Ford Motor Company
Henry Ford founded Ford Motor Company on June 16th, 1903 with several partners in Dearborn, Michigan. During the early years the company produced several vehicles ranging from the Model A in 1903 to The K, in 1907. The most notable of the Ford motor company vehicles is the Model T in 1909. Ford built over 18,000 Model Ts in 1909, by 1912 they were producing over 170,000 which required a move to a larger plant. By this time Ford Motor Company was international and within the next few decades it would expand overseas to include Austria, Argentina, Ireland and Australia to name a few. Henry Ford was in control of the company until his wife and daughter demanded that he give over control of the company to his grandson in 1943. Ford died in 1947, attracting over 7 million viewers at a national level. Ford Motor Company would go on to be the largest and most profitable companies in the world. They would ultimately own 5 other brands including Lincoln, Mercury, Land Rover, Jaguar, Volvo and Aston Martin, by 2008 all would be sold except Lincoln.
Ford Motor Company Capital Structure
In 2012, pre-tax operating profit excluding special items, was $8 billion, or $1.41 per share. Record results of $8.3 billion in North America, continued solid performance from Ford Credit of $1.7 billion, positive results in South America, continued investment in Asia Pacific Africa and began a challenging transition in Europe. 2012 ended with automotive gross cash of $24.3 billion, exceeding debt by $10 billion. A strong liquidity position of $34.5 billion, an increase of $2.1 billion over 2011. With an eye to the future, Ford continued the largest and fastest manufacturing expansion in more than 50 years, adding capacity to support growth plans in North America and Asia Pacific Africa. (Ford, 2012) Although Ford has debt of over $14 Billion they are still positioned to continue to be the top automotive maker in the US. Their debt can be attributed to the decision made by CEO Alan Mulallys decision to borrow $23.6 Billion in 2006 to avoid the recession and ultimately causing others to require government assistance (Taylor, 2009). This decision has afforded Ford the room to make decisions to better their market share in the future.
Business and Financial Risks at Ford
Ford Motor Company has multiple revenue streams including Ford Motor Company as well as Ford Financial services. Ford Motor can be impacted not only by economic recession or the publics review of American made vehicles including trucks that have high gas mileage. With the current increasing gas prices Ford must ensure they are investing in the development of the cost and gas efficient vehicles within its portfolio. Fords decision to increase debt may have given them positive public relations but has put them in a difficult position with limited cash flow needed to continue to grow products. During 2011, global economic growth slowed to about 2.5% from 4% in 2010, as the worsening debt crisis in Europe, regime changes in North Africa, natural disasters in Japan and Thailand, and moderating economic growth in several key newly-developed and emerging markets all contributed to slow growth. Global growth in 2012 remained at the relatively low level of about 2.5% due to the European debt crisis, slowing of Chinese economic growth, and moderate pace of recovery in the United States. During 2013, global economic growth is expected to remain in the 2% 3% range. The European debt crisis remains a key risk to economic growth. The current economic performance in many European countries, particularly Greece, Ireland, Italy, Portugal and Spain, is being hampered by excessive government debt levels and the resulting budget austerity measures that are contributing to weak economic growth. The EU, the European Central Bank, and the International Monetary Fund have provided important support for many of these countries undergoing structural changes. During 2013, economic growth is likely to remain weak in these markets, even though financial markets have begun to stabilize. The U.K. government has implemented budget cuts and tax increases that will depress growth, although the labor market has stabilized in recent months. Uncertainties associated with the European debt crisis, and policy responses to it, could impact global economic performance in 2013. (Yahoo, 2013)
Below is the capital structure as of September 2013. Equity is represented by the Orange equaling 20.5 Billion, with company debt of over 110 Billion.
The Modigliani and Miller Theory of Capital Structure
The Modigliani and Miller theory of capital structure has two propositions: 1) A firms total value is independent of its capital structure, and 2) the return on equity will rise and the debt to equity ratio rises in order to compensate investors for the additional financial risk. The first proposition relies on the assumptions that before tax-operating profits are not affected by capital structure neither are taxes themselves, and the firms capital structure choices do not convey important information to the market. What the Modigliani and Miller means to the Ford and its investors is that since the company was able to get a large amount of cash through taking on debt, to increase the value of the company it needs to use this capital to generate more revenue. Investors will not respond to a rise in the debt levels of the company until they become excessive, what will increase the value of the company is a rise in sales revenue. This is not to say that there is no adverse effects of the company taking more debt and the shareholders will not be any worse off as debt levels go up. There is considerably more risk as the company becomes more and more leveraged. This is the basis for the second proposition to Modigliani and Millers theory, which says that as risk increases the investors expected return also rises to compensate for the additional exposure to risk. The second theorem is what dictates that Ford use its additional capital to generate more income. Without a significant rise in demand for automobiles, Mulallys only choice was to shed assets that were costing too much money and take market share.
Optimal Capital Structure at Ford
Ford Motor Company has seen a large increase in their debt to equity ratio since their decision in 2006 to borrow against their assets. Currently they are seeing a decrease in that ratio to 5.4 as of Sept 2013. According to company disclosure Ford Motor Co has Debt to Equity of 5.4 times. This is 550.0% higher than that of Consumer Goods sector, and 355.56% higher than that of Auto Manufacturers Major industry (axis, 2014).
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axis, M. (2014). Ford Debt to Equity. Retrieved from macro axis: http://www.macroaxis.com/invest/ratio/FDebt-to-Equity Ford. (2012). 2012 Annual Report. Retrieved from Corporate.ford.com: http://corporate.ford.com/doc/ar2012-2012%20Annual%20Report.pdf Taylor III,
A. (2009). Fixing Up FORD. (Cover story). Fortune, 159(11), 44-52. Retrieved from EBSCOhost. Yahoo. (2013, Feb). Form 10-K for FORD MOTOR CO. Retrieved from Yahoo! Finance: http://biz.yahoo.com/e/130219/f10-k.html