General Understanding: Why is Financing Structure so important in Comparing firms? Is it because unlevered companies can take on more debt ( competitive advantage)?
When you buy a bond from a company you’re essentially lending them money. Would you rather lend to a company who has lots of debt already or one that is free and clear of debt? When you’re buying equity in a company you essentially sharing in their profit/growth. Would you rather share in the profit of a company who is getting small returns because they refuse to leverage up and borrow money from others or would you rather be with a company who is intelligently borrowing money to fund expansion because they see opportunities? Sounds pretty important to me for comparing which firm I want to lend money to or invest money with.
Capital structure is one very important factor in comparing firms. Firms with large amount of euity capital than debt have a higher WACC Vs those that have higher debt in their capital structure because of the tax savings on the cost of debt. Higher WACC reduces the value of the firm because - a) higher denominator in FCFF valuation model, and b) higher equity capital providers require higher returns resulting in higher risk. This is why analysts prefer to use optimal (or target) capital structure for analyzing firms in specific industries to make sure they are comparing apples to apples.