Subject: DuPont Case Study

Summary & Recommendations:

Given Du Ponts financial history and current position, we recommend that they forego a low
debt capital structure for a 4! target debt ratio and attempt to cut their dividend" #n the period
of $%&'($%)$, Du Pont had undergone drastic change in their capital structure policy" #ncreases
in industry capacity surpassed demand growth, driving prices down" *long with inflations
effect on re+uired capital spending, the oil shoc, driving up costs, a recessionary environment
for the industry, and the vertical ac+uisition of Conoco, Du Ponts capital structure was near
unrecogni-able by the end of the transitionary period" Du Ponts debt ratio stood at 4.!, up from
less than .! and eventually led to a downgrading of the firms credit rating to **" Due to
Conocos performance after the ac+uisition, the firm was in a troubled situation" Du Pont sold a
part of Conocos assets dropping its debt ratio to /&!0 Despite +uestionable financial ratios and
poor earnings in )., Du Pont maintained its ** rating"
Key Issues
1he pec,ing order theory postulates that maintaining a 4! debt level would be ideal
over the target .'! debt scenario" 2educing the debt ratio would re+uire large issuing of
e+uity, a source of capital that is more e3pensive than debt" *dditionally, Du Ponts
diversified business units provide e3tra protection from the added(on ris, of debt
Du Ponts shares are undervalued due to investor conceptions from previous financial
performance" 1he Conoco ac+uisition, although costly and unluc,y, reduces costs for Du
Pont as its vertical integration potential is still largely untapped" #ssuing e+uity would
only signal the boards belief that the share price is accurate4over(valued, driving the
price down even further" 5ther industry competitors are at a 4! debt level
*ccording to the 676 theorem, Du Ponts value as a firm is correlated to its debt level"
1he 4! debt scenario will yield higher dividends per share, earnings per share, and
258"
#ncreasing target debt levels would send positive signals to the mar,et by demonstrating
the ability to increase debt levels while staying financially stable" 1his should lead
investors to focus on anticipated future growth"