Effect of capital structure on the stock returns in the pharmaciutical industry only in the UK

Effect of capital structure on the stock returns in the pharmaciutical industry only in the UK. Write a brief summary statistics and explain the correlation results.

Effect of capital structure on the stock returns in the pharmaciutical industry only in the UK
Effect of capital structure on the stock returns in the pharmaciutical industry only in the UK. Write a brief summary statistics and explain the correlation results.

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The ratio of debt to equity is an indicator of the probability of bankruptcy, which generally reduces the value of equity to zero, leaving equity investors with nothing to show for their investment.

Imagine a business that earns a profit of $50 a year on revenues of $500, as it has fixed costs of running their factory of $400, and variable costs of $50.

Let’s say this business wants to build a second factory, and needs to raise $400 to increase their profits to $100/year on revenues of $1,000/year. The second factory is the same as the first, with $400 in fixed costs, and variable of $50.

Imagine the company has 50 shares of stock outstanding, and each share is currently worth $10. To raise $400, the company could sell another 40 shares of stock. Originally, each shareholder had $1 of earnings for each share of stock they had. ($50 profit / 50 shares = $1 profit per share, or EPS). Now that they have issued the additional shares of stock, each shareholder has ($100 profit / 90 shares = $1.11 of profit). They are happier because they have higher EPS.

Instead, let’s say the company decides to issue $400 in debt to pay for the expansion, at an interest rate of 10%. The company has an operating income of $100, pays $40 in interest, and has a net profit of $60. Since the company only had 50 shares, the EPS, or profit per share is $1.20 ($60 / 50 shares). Now the shareholders are really happy because their earnings are even higher.

At least we would think they would be happier, right? But let’s pretend the following year there is an economic downturn, and revenues fall 10%, which is not an unlikely outcome. Now the company has revenue of $900, still has to pay their fixed costs of $800, and has variable costs of $90, and interest of $40.

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