Cummins Inc.: A Sensitivity Analysis of Capital Structure

Yinuo Su

Co-Presenters: Individual Presentation

College: College of Business and Public Management

Major: BS.FINANCE

Faculty Research Mentor: Kakolyris, Andreas  

Abstract:

This study examines how changes in leverage affect the weighted average cost of capital (WACC) of Cummins Inc. (CMI) and aims to identify a potentially optimal capital structure. Founded in 1919, Cummins is a global leader in power and engine technologies. As a capital-intensive manufacturing firm, its financing decisions play a critical role in sustaining long-term competitiveness and maximizing firm value, making it an appropriate and meaningful subject for capital structure analysis.The analysis is based on financial data collected from the Bloomberg Terminal, including earnings before interest and taxes (EBIT), free cash flow, beta, outstanding debt, and a constant corporate tax rate. The cost of equity is estimated using the Capital Asset Pricing Model (CAPM), with beta adjusted under different leverage scenarios. The cost of debt is derived using the interest coverage ratio (ICR) and a synthetic credit rating approach. We simulate alternative capital structures ranging from 10% to 70% debt and compute the corresponding WACC to evaluate its sensitivity to leverage.The results indicate that at low to moderate leverage levels, the tax shield benefits of debt reduce WACC. However, excessive leverage substantially increases financial risk, driving up both the cost of equity and the cost of debt, and ultimately raising WACC. The findings suggest that WACC reaches its minimum at approximately a 30% debt ratio. This study highlights the strategic importance of capital structure decisions for large manufacturing firms. In an environment characterized by interest rate volatility and economic uncertainty, the analysis provides a quantitative framework to help managers balance risk and return when designing long-term financing strategies.