Some other risk factors include substantial cyclical fluctuation, the effects of unseasonable weather conditions, and the popularity of the outdoor activities. In order to minimize the negative impacts on this business, the company started a series Of strategic initiatives, such as product innovation program, new multi-channel and multi-country direct-to-consumer platform, information management and their enhanced marketing efforts. All those improvement and implementation involve significant investment in SO&A expenses and its fixed cost.
Thus it is essential to look back and evaluate their current capital structure and payout policies to exam whether the company would start on carrying debt or whether they have residual cash return to their investors. Despite Columbians regular dividend payouts and stock repurchases, they does not maintain a healthy cash and short-term investment balance. According to the financial data provided in Annual Report, the major financing needs include capital expenditures, working capital expenses, stock buybacks, and dividend payouts. In 201 1 , Columbia spent $78 million in capital expenditure and $92. Million in working capital investments; which was increased from $29 million and $78. 9 million from last year. Even though the company’s net income increases over time, they have generated negative free cash flow for both fiscal year of 2011 and 2010 with around $14. 6 million and $53 million respectively. Currently, the company sales short-term investments to finance those capital expenditures which should not be a long term strategy as the company only has $2. 9 million short-term investments sitting on the balance sheet at the end of 2011.
If the company maintains its profitability and its capital structure as the end of Fiscal year 2010, Columbia will have significant financial difficulties to meet capital expenditure requirement and will have emitted resources for distribution to investors in the form of a cash dividend and stock repurchases with current payout rate. In conclusion, Columbia may need to seek additional funding. Even though, historically the company have limited their reliance on debt to finance their working capital, capital expenditures and investing activity requirements.
We suggest that the company need to revise their capital structure policy by increasing debt to finance the business activities. Debt not only can provide coverage for any general costs and unforeseen expenses, it also serves as a tax shield allowing more capital to be available to investors. The assumption here is that the company can earn more in tax savings from borrowed funds than it pays in interest expenses and fees on these funds. As shown in Exhibit X, Columbians WAC hit a minimum of 6. 6% at 30% debt ratio, or debt to equity ratio of 0. 3. As the graph illustrates below, less than 30% debt or debt beyond 40% cause WAC to increase. Also, the PEPS and ROE increase compared to the current 100% equity model. In a business, debt is a two-edged sword. Aggressive use of leverage increases the amount of financial resources available for growth, expansion, and payout for investors. But if Columbia adopts a highly leveraged capital structure policy, it may find its freedom of action restricted by its creditors and its profitability may hurt as a result of paying high interest expenses.
It may also affect the company’s profitability and liquidity when the business has trouble meeting Operating and debt liabilities during unfavorable economic conditions. Additionally, too much debt versus equity would potentially affects business’ credit rating, which is the evaluation of a company’s ability to repay principle and interest on debt obligations. Since the company do not have much experience on carrying debt on their lance sheet, we recommend the company to start the process slow.