HISTORY

Historically known for its policy of extreme financial conservatism. Low debt possible due to success in products markets.

High profitability allowed finance needs to be internally funded.

One of the few AAA rated manufacturers. 1965 1970 : Capacity outstripped demand leading to price falls and drop in net income by 19%.

HISTORY (contd)

1970 1975: High inflations, rising oil prices and recession impacted the business. The company finally resorted to debt financing. 1975 : $540 mn in short term debt and $340 mn in long term debt. Debt ratio rose to 27% and interest coverage dropped to 4.6 1979 : Debt ratio reduced to 20% and interest coverage rose to 11.5%.

CONOCO TAKEOVER

1981 : Took over Conoco, Inc, a major oil company at a premium of 77% above pre-acquisition market value. The acquisition was debt financed and the debt ratio of Du Pont rose to 42% after the acquisition. Du Pont got downgraded to AA rating. 1982 : Debt ratio was down to 36%, interest coverage was at 4.8 and the company retained its AA rating.

SCENARIO ANALYSIS Scenario 1 : Maintaining a 40% target debt ratio The Positives:

It results in increased Return on Equity (ROE). Net Income and EPS also increase due increase in interest expense, which is tax deductible. This results in lower tax expense and eventually leading to greater net income.

The company should save approximately $ 266 million over five years from the increased tax shield due to the additional leverage.

RISK

A major area of concern is the high risk associated with the 40% target debt ratio. Cost of debt will be more expensive because its bond rating will drop to A. Risks include the lower interest coverage and lesser access to debt funds. This means that the company may not be able to pay its interest on time and funds are not always available when needed.

OTHER FACTORS

The 40% debt ratio is still below the industry average. The risks are workable because, this move might make them even more competitive in its financing. High tax savings result from the 40% debt ratio which will generate cash flow for DuPont.

Trade-off: Flexibility Vs Control

DuPont is more flexible under the 25% debt ratio but will dilute present stockholders control over the company. Control is higher under 40% debt ratio but flexibility is poor.

CONCLUSION

The capital structure with 25% debt is optimal:

We believe that company control should be prioritized over flexibility. High risk associated with the 40% target debt ratio. value of firm is increased in the lower debt Restore confidence and give the firm greater financial freedom to fund research and development and pursue new projects.