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Welcome to Corporate Finance Explained, where we break
down the essential topics every corporate

finance professional needs to know. This series is narrated
by AI, created using CFI's expert training

materials and designed to help you stay ahead in the
world of finance. Enjoy this week's deep dive.

All right, so you want to understand how companies make
those big money decisions, you know, where they

get the fuel for growth acquisitions, all that. It's
called capital structure. And it's way more

exciting than it might sound at first. Yeah, it really
is. We're talking about the balance of debt

versus equity financing. The classic. And believe me,
those choices have real world consequences for

all of us. Absolutely. What's intriguing is how this
balance can really make or break a company. Right.

You know, we're not just talking definitions here, but
how these decisions play out for companies you

probably use every day. Exactly. Apple, Tesla, Airbnb,
they're all wrestling with these choices

constantly. That's the right day. So our mission in this
deep dive is to unpack not just what debt and

equity are, but how they shape the destinies of companies
in ways you might not expect. Yeah, for sure.

Let's start with a classic example. Okay. Amazon's

purchase of Whole Foods back in 2017
for a cool $13.7 billion.

They opted to finance that mostly through debt. Wait,
debt? Amazon's a giant. Yeah. Why not just use

their own cash? Smart question. Yeah. So interest rates
were super low at the time. Okay. Making debt

cheap. Right. Plus by using debt, Amazon avoided diluting
its stock. Yeah. Keeping ownership more

concentrated. Interest. That's the kind of strategic
thinking we're going to explore. Okay. So debt can

be a good place sometimes. Yeah. But it's obviously not
the whole story. Right. Let's break down each

side of this coin. Okay. What are the nuts and bolts
of debt financing? Right. Is it actually a good

idea? Debt at its core is borrowing money. Okay. It could
be a bank loan, corporate bonds, you name it.

Okay. The key is you have to pay it back with interest.
Right. Now this might sound simple. Yeah. But

it's where things get interesting. I'm already sensing
there's more to it than meets the eye. Yeah. So

what are the upsides of going the debt route? I think
the big one is cost. Debt is often cheaper than

equity. Really? Because those interest payments are tax
deductible. Oh, right. A nice little perk for

companies. Plus you don't give up any ownership. Interesting.
But of course there's a catch. There's

always a catch. Always a catch. Lay it on me. What are
the risks? Those mandatory repayments. Okay.

They're the double-edged sword. Okay. They got to be made
whether your business is booming. Right. Or

barely scraping by. Yeah. If a company takes on too much
debt. Uh-oh. A few bad quarters could spell

disaster. It makes sense. It affects your credit rating
too, right? Oh, for sure. So you're constantly

maxing out your credit cards. Yeah. Lenders get nervous.
Exactly. Yeah. Too much debt can lead to

credit downgrades. Oh, right. Making future borrowing
more expensive. In extreme cases, it's the road

to bankruptcy. Yeah. And remember, economic downturns
amplify these risks. Oh, of course. Suddenly that

manageable debt. Yeah. Becomes a huge burden. So debt
is a bit of a gamble. High reward, but the

potential for a nasty fall too. Yeah, for sure. What
about equity then? Right. It sounds safer. It

does. But I'm guessing it's not that simple either. You're
catching on quickly. Well. Equity financing

is all about selling ownership stakes in your company.
Okay. Usually through issuing stock. It's like

bringing in partners. Right. Each with a slice of the
pie. Okay. So less renting money like with debt

and more like sharing the house. Yeah. I like that. What
are the benefits there? Well, volatility is

key. Okay. No mandatory repayments looming
over your head. Right. Which

can be a lifesaver for young companies. Yeah.
Or those in volatile markets.

Airbnb's pandemic survival tactic comes to mind. Oh,
right. They needed cash fast. Yeah. And issuing

stock at that time would have been disastrous. Why disastrous?
What's the downside of equity? Delusion,

my friend. Delusion. Every time you issue new shares.
Yeah. You're cutting that ownership pie into

smaller slices. Existing shareholders get a smaller
piece. Mm-hmm. Potentially impacting their

investment. So it's a trade off. It is. Flexibility and
cash now. Right. But at the cost of sharing

future profits more widely. Exactly.
Are there any other drawbacks?

Equity financing also tends to be more expensive than debt.

Really? Those investors buying your stock expect a return.
Okay. Either through dividends. Right. Or

stock price appreciation. Mm-hmm. It's not just about
the ownership stake. Yeah. It's the ongoing cost

of keeping those investors happy. Especially for public
companies, right? Especially for public

companies. Wall Street's always watching, demanding
growth and returns. Always watching. Yeah. So

equity has its allure. It does. But it's not a free lunch
either. Not at all. All right. So both debt

and equity have their pros and cons, their moments to
shine, and their potential pitfalls. Right. This

has reminded me of something you said earlier about
Apple. Oh, yeah. They're thinking about their

massive cash reserves. Yes. Yet they still issue debt.
It seems counterintuitive. It does. But there's

a strategic reason behind it. Yeah. It's like having
a million dollars in the bank. Uh-huh. Still

taking out a loan. Yeah. What's the logic there? Tax
strategy at its finest. Okay. Apple's cash is

mostly held overseas. Oh. To minimize their US tax burden.
Right. Bringing it back would trigger a huge

tax bill. Wow. They borrow at low rates instead. Okay.
That's actually cheaper than using their own

cash. Wow. That's some next-level financial maneuvering.
Yeah. They're very smart. It sounds like Apple

has this whole capital structure game figured out. They're
definitely playing it strategically. Yeah.

But let's not forget, every company's situation is unique.
Right. Take Tesla, for example. Okay. Their

journey with debt and equity has been quite different.
Yeah. They've gone through explosive growth. Oh,

yeah. I bet their financing needs have been wild. Wild
is an understatement. Tell me more about their

approach. Early on, Tesla was a risky startup. Traditional
lenders weren't exactly lining up to throw

money at them. Right. So they relied heavily on equity

financing. Yeah. Stelling off pieces of
the company to fuel their growth.

Makes sense. High risk, high reward. High risk, high
reward, exactly. But it must have come at a cost,

right? It did. They issued a lot of stock. Oh. Deluding
early investors. Okay. But it was the only way

to secure the funding they needed. Yeah. To get off
the ground. As they matured, their cash flow

increased, giving them more options. Exactly. So they
started using more debt as they became more

established. Yeah. Like graduating from credit cards
to a proper mortgage. Precisely. They

strategically took advantage of low interest rates to
secure loans. Okay. Funding expansion. Mm-hmm.

While minimizing further dilution. That makes sense. It's
fascinating how a company's capital structure

can evolve alongside its growth. It really is. All
right. So we've got these real world examples

showing us how these choices play out. Right. But what
about the bigger picture? Okay. What factors do

companies consider when trying to strike that ideal balance
between debt and equity? There's no one

size fits all answer. Okay. But let's look at some key
things they weigh. All right. First, industry

norms. Okay. Some sectors are naturally debt heavy.
Mm-hmm. Like airlines and utilities. Why those

specifically? What makes them different? They require
massive upfront investments. Okay. Planes, power

plants, infrastructure. Yeah. Debt financing is often
the only way. Oh, really? To get those projects

off the ground. So the nature of the business itself
plays a role. Definitely. Or else. Market

conditions are huge EE. Okay. Low interest rates
make debt more tempting. Right. High rates.

Companies might lean on equity instead. So it's about
timing too. It's like timing the stock market.

Right. But for borrowing money. Yeah. So it's a bit of
a gamble too. It is. Interesting. Do companies

factor in their own personality? Oh, totally.
When making these choices. Absolutely.

Risk tolerance varies wildly. Right. Some companies are
inherently conservative. Okay. Prioritizing a

strong balance sheet. Mm-hmm. Even if it means slower
growth. Exactly. Others are more aggressive.

Yeah. Embracing leverage to fuel rapid expansion. Oh,
okay. So different approaches. Very different.

It's like some folks are comfortable with a mortgage.
Uh-huh. While others prefer to save up and buy

their house outright. Right. Different strokes for
different folks. Exactly. And of course we can't

forget about those lovely taxes, right? Oh, never forget
about taxes. They always get their cut. They

always do. Tax implications are always on the table. Okay.
Remember Apple's overseas cash dilemma? Yes.

Those considerations can make a huge difference in choosing
debt or equity. Okay. So we've got this mix

of industry norms. Mm-hmm. Market conditions. Right. Risk
appetite. Yes. And those ever-present taxes.

Always there? It's a lot to juggle. It is. I bet there
are some theories out there trying to make sense

of it all. Oh, there are plenty. Okay. I'm all ears. Hit
me with some of these theories. Okay. That try

to crack the capital structure cloud. One famous one is
the pecking order theory. Packing order. Okay.

It suggests companies have a preferred order. Internal
funds first. Then debt. Right. And lastly,

equity is a last resort. So it's like use your own piggy
bank first. Then borrow from a friend. And

only sell your prized possessions if you're desperate.
That's the gist. Okay. It minimizes costs.

Right. And maintains control. Makes sense. Another
influential one is the Modigliani-Miller theorem.

Modigliani-Miller. Okay. Which proposes
that in a perfect world. A

perfect world. Capital structure wouldn't
even matter. Now that's intriguing.

Tell me more about this utopian vision. The idea is that
without taxes, bankruptcy costs. Right. Or

other market imperfections. Okay. A company's value is
solely determined by its assets and earnings,

regardless of how it's financed. So the mix of debt and
equity is irrelevant in this perfect world. In

theory, yes. Sounds a bit too good to be true. You got
it. We don't live in a perfect world. Sadly, no.

Taxes bankruptcy risks. Yeah. We're talking about the
capital structure of very real concern. Right.

These theories provide food for thought. Right. But
ultimately, each company has to find its own path.

All right. So we've got these maps and compasses. Yeah.
But the terrain is constantly changing. It is.

All right. We've covered a lot of ground in this first
part. We have. Debt versus equity. Mm-hmm. The

factors at play. Those fascinating examples of Apple
and Tesla. Definitely. What are some of the key

takeaways so far? I think we've learned that capital
structure is a dynamic balancing act. Right.

Okay. Debt can be cheaper but riskier. Mm-hmm. While equity
offers flexibility but dilutes ownership.

Yeah. And real world factors like industry norms, market
conditions. Right. And even a company's risk

appetite all play a part. It's more than just a numbers
game. Yes. It's about understanding how these

choices impact a company's ability to grow. For sure.
Navigate risks and ultimately achieve its goals.

Absolutely. I'm ready to dive even deeper into how to
actually analyze these choices. Yeah. Like a

financial detective. That's exactly where we're headed
in part two. Sounds good. We'll equip you with

the tools to decipher those financial statements. Oh,
okay. Understand key ratios. Mm-hmm. And even

spot potential red flags. Sounds good. Until then, keep
thinking about those companies you interact

with every day. Yeah. Are they playing it safe with equity,
leveraging up with debt. Right. Finding

some clever hybrid approach. The answers might surprise
you. They might. All right. We've laid the

groundwork. Debt versus equity, those strategic choices
companies make. Right. But how do we, the

non-financial wizards, actually analyze a company's capital
structure? Yeah, good question. Where do we

even start? It's like learning a new language. At first,
those financial statements seem intimidating.

Yeah, they can be. But once you know the key phrases,
it opens up a whole world of insight. Okay, so

we're talking financial statements. Yeah. I know those
can be debts. Yeah. But you're saying they hold

valuable clues. Totally. Like a treasure map to a company's
financial health. Exactly. And the best

part is they're publicly available for most companies.
No, that's good. Two key ones for capital

structure analysis are the balance sheet and the income
statement. All right, the balance sheet. Right.

That's the snapshot of what a company owns, assets,
and how they're financed. Right. So, you have

liabilities and equity? Precisely. Think of it as a scale.
Okay. On one side, you have assets. Yeah.

And on the other, you have liabilities and equity. Right.
The proportions here tell a story. Okay. If a

big chunk of those assets are financed by debt, that
company might be highly leveraged. Leveraged

meaning they're using a lot of borrowed
money. That's right. And that's

not always a bad thing, is it? They're
getting it. Context is key. Okay.

So, for a company in a stable industry with predictable
cash flow, like a utility company, a lot of

debt might not raise too many eyebrows. Okay. But for
a company in a volatile market where things can

change quickly, high leverage could be a sign of trouble.
So, like a tire-up walker, they need to be

really good at balancing to avoid a nasty fall. Yeah,
for sure. What about the income statement? The

income statement. What clues does that hold? Yeah, what's
in there? The income statement is all about

profitability over a period of time. Okay. We're looking
at how much of their earnings are being

gobbled up by those interest payments. Ah. So, if a big
chunk of their profits is going straight to

servicing debt, that leaves less for things like reinvesting
in the business. Right. Innovating, or

even paying dividends to shareholders. Exactly. It could
be a sign that their capital structure is

actually holding them back from reaching their full
potential. Okay, we've got these two key

statements. Yep. But I'm guessing there are ways to cut
through the noise. Oh, yeah. And make sense of

all those numbers, right? That's right. Some secret
decoder rings for financial statements. That's

where financial ratios come in. Oh, okay. Financial ratios.
They're like shortcuts, giving you quick

insights into a company's leverage and financial health.
Right. One of the most common is the debt to

equity ratio. Okay. Debt to equity. Yeah. That sounds
fairly self-explanatory. It is. Debt compared to

their equity. Exactly. What's a healthy range there?
There's no magic number. Okay. But a ratio above

two might make you pause. Oh, okay. It suggests the company
is relying heavily on borrowed money. Yeah.

Which could make them vulnerable. Make sense. Are there
any other ratios that are particularly useful

for deciphering a company's capital structure? Another good

one is the times interest earned ratio.
Times interest earned.

It tells you how easily a company can cover its interest
expense with its earnings. So if a company is

barely scraping by, making just enough
to cover their interest payments,

that ratio would be pretty low, right? Exactly. A low
times interest earned ratio is a red flag. Okay.

Yeah. Red flag. It means they're walking a tight rope and
could easily stumble if their earnings take a

hit. Right. All right. So we're armed with our financial
statements. We're going to have these handy

ratios. Yep. And we're starting to decode the story of
a company's capital structure. We're getting

there. But it's not just about the numbers, is it? You're
spot on. There's more to the picture, right?

Numbers alone don't tell the whole story. Okay. We need
to consider the qualitative factors too. All

right. The company's industry, their growth potential,
the overall economic climate. Right. Like two

companies could have similar debt to equity ratios.
Yeah. But one might be a risky startup and the

other a well-established giant. Exactly. Apples and oranges,
basically. Basically apples and oranges. A

high debt load might be acceptable for a fast growing
tech company. Okay. Plowing money back into

innovation. Right. But for a mature company in a slow
growing industry, that same level of debt could

be cause for concern. It's like those personal finance
gurus who say, don't compare your spending to

your friends. Right. Everyone's situation is different.
I love that analogy. And just like with

personal finance, you need to look beyond the surface.
Definitely. Read industry reports, understand

the competitive landscape. For sure. And consider the
management team's track record and strategic

vision. Absolutely. It's like being a detective. Right.
Piecing together clues from different sources

to get the full picture. So we've talked about analyzing
existing capital structures. Yeah. But what

about those moments when companies decide to shake things
up. Right. To change their financing mix.

Those are some of the most exciting moments. Oh really?
They often signal a strategic shift. A bold bet

on the future or a response to changing market conditions.
All right. Let's break down these scenarios.

When might a company decide to take on more debt? A
common reason is to fund a major investment.

Building a new factory, acquiring a competitor, expanding
into a new market. Makes sense. Debt can be a

powerful tool for growth, especially when interest rates
are low. I feel like taking out a mortgage to

buy a bigger house. Yeah. But on a corporate scale.
Exactly. And just like with a mortgage, companies

need to be confident they can generate enough cash flow
to cover those debt payments. Makes sense. What

about issuing new equity? When is that the right move?
Companies might turn to equity when they need a

big cash infusion, but don't want to or
can't take on more debt. Maybe

they're in a risky industry or they're worried
about becoming too leveraged.

Or maybe they're riding a wave of hype. Oh, yeah.
Their stock price is soaring and they see an

opportunity to raise capital at a favorable valuation.
You got it. Issuing equity when your stock is

hot can be a savvy move. You raise a lot of money
without taking on debt or diluting existing

shareholders too much. So it's a bit of a balancing act.
It is. Weighing the cost of dilution against

the benefits of raising capital. For sure. Now, what about
those share buybacks we mentioned earlier?

Oh, yeah. Share buybacks. Why would a company buy back
its own stock? Yeah, why would they do that?

Share buybacks or stock repurchases are fascinating.
Okay. The company uses its own cash to buy back

shares from the open market. Right. Essentially reducing
the number of shares outstanding. So fewer

slices of the pie. Right. Which could make each existing
slice more valuable. Precisely. It can boost

earnings per share. Okay. It's a symmetric investors
watch. And it signals the company believes its

stock is undervalued. Interesting. Like saying, we think
our stock is a bargain, so we're buying.

That's a powerful statement. It is. It's like putting
your money where your mouth is. It seems like

share buybacks can be a way to reward shareholders, boost
the stock price, and maybe even fend off a

hostile takeover. You've hit all the key points. Wow.
It's a versatile tool. Okay. Understanding why a

company is buying back its own stock can provide valuable
insights. This whole conversation has really

highlighted the complexity of capital structure. It really
has. It's more than just crunching numbers.

It is. It's about understanding the strategic implications
of these choices. Right. And how they can

shape a company's destiny. Absolutely. It's not a
static concept. Right. Capital structure is

constantly evolving. Okay. As companies adapt to new
markets, regulations, and even global events. All

right. Before we jump into the future of capital structure,
let's recap the key takeaways from this

segment. Sounds good. We learned that analyzing a

company's capital structure starts with
those financial statements.

The balance sheet and income statement, they're packed
with clues about a company's leverage and

financial health. We also explored those handy financial
ratios, like debt to equity and time's

interest earned, which help us cut through the noise and
quickly assess a company's risk profile. For

sure. But we emphasize that numbers don't tell the whole
story. Right. They don't. We need to consider

qualitative factors too. Absolutely. Like the company's
industry growth prospects and even the

management team's vision. It's all part of the puzzle.
We also looked at those pivotal moments when

companies changed their capital structure. Yeah. Taking
on more debt for expansion. Issuing new equity

for growth. Right. Even buying back their own stock
to boost shareholder value. For sure. It's a

dynamic process. It is. With companies constantly
evaluating their options and adjusting their

approach. Absolutely. Now, as we look ahead, I'm curious
about those emerging trends you mentioned

earlier. What's on the horizon for capital structure?
Yeah. What's coming next? What new forces are

shaping these decisions? That's where things get really
interesting. All right. I like where this is

going. We're seeing the rise of alternative financing.
The growing influence of ESG factors. Right.

It's a whole new landscape out there. Sounds like we're
in for a wild ride. We are. I'm ready to dive

into these trends and see how they're changing the game.
Let's do it. All right. We've gone from debt

versus equity all the way to analyzing companies like
financial detectives. Yeah. But now let's look

ahead. Okay. What's changing in the world of capital

structure? Right. And what does it mean
for investors, businesses?

Really anyone who wants to understand how money makes
the world go round? That's a big question. It is

a big question. One trend that's impossible to ignore is
the rise of alternative financing. Alternative

financing. We touched on this earlier.
Yeah. Crowdfunding, venture debt.

These aren't just noosh players anymore. They're becoming
mainstream. Okay. Especially for startups and

smaller companies. It used to be you had limited options.
Yeah. Bank loans, maybe some angel investors.

Yes. If you were lucky, venture capital. If you were
really lucky. Now it's like a whole buffet of

funding choices has opened up. It really has. What's
driving this shift? I think technology is a huge

factor. Okay. Online platforms connect companies and
investors, making fundraising faster, easier, and

often cheaper. Right. It's democratizing access to capital
in a way we haven't seen before. And I

imagine the tighter lending standards after the financial
crisis played a role too. For sure.

Yeah, they did. Making it tougher for some companies to
get traditional loans. Definitely. That created

a vacuum for alternative financing to step in and
fill the gap. Right. So it's a mix of tech

innovation, changing regulations, and evolving market
dynamics. It's a whole new world out there. But

how is this impacting capital structure decisions? Yeah,
that's the key question. Is it changing the

game or just adding some new pieces? I think it's giving
companies more options. Okay. It's the ability

to tailor their financing to their specific needs. They're
no longer stuck with just the debt or equity

dilemma. So they can mix and match, get creative with
their funding cocktail. Precisely. We might see

companies using a blend of traditional bank loans,
convertible debt, equity crowdfunding,

and venture debt. Wow. It's about crafting a capital
structure that fits their risk appetite. Right.

Growth goals and stage of development. It's like those
build your own burrito places. Yeah. Everyone

gets exactly what they want. I like that analogy. But this

requires some serious financial expertise,
right? Absolutely.

Companies need a savvy team who understand these new
financing models. Not just the numbers, but the

legal and regulatory aspects, the impact on investors,
even corporate governance. It's complex stuff.

Okay. So alternative financing is shaking things up.
Definitely. What other trends are on the horizon?

What else might disrupt the world of capital structure?
One that I'm particularly interested in is the

growing focus on sustainability. Okay. Sustainability.
And ESG, environmental, social, and governance

factors. ESG is everywhere these days. It really is.
But how is it impacting how companies raise and

manage capital? We're seeing new financial instruments
emerge. Okay. Like green bonds and

sustainability-linked loans. Green bonds, sustainability-linked
loans. But these, the interest rate a

company pays is tied to their performance on ESG metrics.
So if a company hits their sustainability

targets, they get rewarded with a lower interest rate.
Exactly. That's amazing. It aligns financial

incentives with doing good for the world. It does. It's
attracting investors who want both financial

returns and positive impact. Makes sense. Companies
that ignore ESG might find it harder to access

capital. Oh, interesting. And those that embrace it
could have a real edge. So it's not just about

being good anymore and it's becoming a smart business
move. Absolutely. Impacting their cost of

capital. Exactly. That's a powerful shift. It
is. It's driving innovation and finance.

We might see even more new tools emerge. Yeah. That support
sustainable investments. Right. And reward

responsible companies. For sure. This is all so fascinating.
It is. It feels like we're witnessing a

fundamental change. Yeah. I think about money and its role
in society. I agree. It has the potential to

create a more sustainable, equitable and prosperous future
for everyone. Well said. This has been an

incredible deep dive. It has. From the basics of debt
and equity to the trends shaping the future of

finance. We've covered a lot of ground. We have. Before
we wrap up, let's recap the key takeaways from

this final segment. Sounds good. We've explored the rise
of alternative financing with crowdfunding and

venture debt, giving companies new ways to access capital.
Right. And we discussed how this is allowing

companies to create more customized capital structures,
moving beyond the traditional debt or equity

choice. Exactly. We also delved into the growing importance
of ESG factors with green bonds and

sustainability link loans becoming increasingly popular.
And it's clear that these trends aren't just

fleeting fads. No, they're not. They're reshaping the
financial landscape. Absolutely. And pushing us

towards a more sustainable and equitable future. I couldn't
agree more. So as we conclude this deep

dive, I want to leave you with this thought. As technology
continues to advance at an incredible pace,

what new and innovative capital structure models might
emerge? Yeah, what's next? How will AI,

blockchain and other emerging technologies disrupt the
world of finance and create new opportunities?

Those are excellent questions. They are big questions.
The answers will shape the future of capital

structure and the global economy for generations to come.
Thanks for joining us on this exploration of

capital structure. It's been a pleasure. We hope you've
gained valuable insights to help you navigate

the ever-changing world of finance. Yeah, definitely.
Until next time, keep exploring, keep learning

and keep asking those insightful questions. That's the
key. Thanks for listening to Corporate Finance

Explained. If you found this episode valuable, be sure
to check out more episodes and explore CFI's

highly-rated courses at corporatefinanceinstitute.com.
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