Free Cost of Capital at DraftKings Case Study Solution | Assignment Help

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Written by Gary F. Smith
Publish Date: 2024-12-03

Harvard Case - Cost of Capital at DraftKings

"Cost of Capital at DraftKings" Harvard business case study is written by Malcolm P. Baker, Sebastian Hillenbrand, James Barnett. It deals with the challenges in the field of Finance. The case study is 15 page(s) long and it was first published on : Sep 11, 2023

At Fern Fort University, we recommend DraftKings pursue a balanced capital structure prioritizing debt financing to fuel its growth strategy while maintaining a healthy risk-adjusted return on investment (ROI). This approach will allow DraftKings to capitalize on its strong market position in the rapidly growing sports betting and iGaming industry while mitigating potential financial risks associated with aggressive equity dilution.

2. Background

DraftKings, a leading provider of daily fantasy sports and online sports betting, faces a critical decision regarding its cost of capital. The company is considering a leveraged buyout (LBO) by a private equity firm, which would significantly alter its capital structure and impact its future growth prospects. This case study examines the potential implications of this decision and explores alternative financing strategies for DraftKings.

The main protagonists are Jason Robins, DraftKings' CEO, and the private equity firm considering the LBO. Both parties need to carefully analyze the potential risks and rewards associated with this transaction, considering the company's current financial performance, future growth potential, and the competitive landscape of the sports betting and iGaming industry.

3. Analysis of the Case Study

This analysis utilizes a financial framework to assess DraftKings' current financial position and the potential impact of the LBO. We will focus on the following key areas:

  • Financial Analysis: Examining DraftKings' financial statements (income statement, balance sheet, and cash flow statement) to understand its current profitability, liquidity, and leverage. We will utilize ratio analysis to assess key metrics such as profitability ratios, liquidity ratios, and asset management ratios.
  • Capital Budgeting: Evaluating the potential impact of the LBO on DraftKings' cost of capital and its ability to fund future growth projects. This involves analyzing the weighted average cost of capital (WACC) and the impact of increased debt financing on the company's overall risk profile.
  • Risk Assessment: Identifying the potential risks associated with the LBO, including increased financial leverage, potential for covenant violations, and the potential for conflicts of interest between management and the private equity firm.
  • Valuation Methods: Assessing the fair market value of DraftKings using various valuation methods, including discounted cash flow (DCF) analysis, comparable company analysis, and precedent transaction analysis.

4. Recommendations

Based on the analysis, we recommend the following:

  1. Pursue a balanced capital structure: DraftKings should prioritize a combination of debt and equity financing to maintain a healthy financial profile and maximize shareholder value.
  2. Utilize debt financing strategically: Leveraging debt financing can provide a lower cost of capital compared to equity financing, allowing DraftKings to fund its growth initiatives more efficiently. However, it's crucial to manage debt levels carefully to avoid excessive financial leverage and maintain a healthy debt-to-equity ratio.
  3. Negotiate favorable terms with potential lenders: DraftKings should leverage its strong market position and growth potential to secure competitive interest rates and flexible loan terms.
  4. Maintain a strong focus on profitability and cash flow management: DraftKings should continue to prioritize operational efficiency and cost control to generate strong cash flows and support its debt obligations.
  5. Consider alternative financing options: Exploring other financing options, such as private placements, convertible debt, or strategic partnerships, can provide additional flexibility and reduce reliance on traditional debt and equity financing.

5. Basis of Recommendations

These recommendations are based on the following considerations:

  • Core competencies and consistency with mission: The recommended approach aligns with DraftKings' mission to be a leading provider of sports betting and iGaming experiences. By leveraging debt financing strategically, DraftKings can continue to invest in its core competencies and expand its market share.
  • External customers and internal clients: This strategy will benefit external customers by providing them with a wider range of betting and gaming options, while internal clients (employees) will benefit from the company's continued growth and expansion.
  • Competitors: The recommended approach will allow DraftKings to compete effectively with other players in the sports betting and iGaming industry by providing the necessary financial resources to invest in technology, marketing, and product development.
  • Attractiveness ' quantitative measures: The recommended approach is expected to result in a higher return on investment (ROI) and a stronger cash flow position for DraftKings.
  • Assumptions: These recommendations are based on the assumption that DraftKings will continue to experience strong growth in the sports betting and iGaming industry and maintain its competitive advantage.

6. Conclusion

By pursuing a balanced capital structure and leveraging debt financing strategically, DraftKings can optimize its cost of capital, maximize shareholder value, and continue to grow its business in the rapidly evolving sports betting and iGaming industry. This approach will enable the company to navigate the challenges of the market, maintain its competitive edge, and achieve its long-term goals.

7. Discussion

While the recommended approach offers a strong path forward, there are alternative options worth considering:

  • Going public (IPO): An IPO could provide DraftKings with access to a large pool of capital, but it would also subject the company to increased scrutiny from investors and regulators.
  • Mergers and acquisitions (M&A): Acquiring smaller competitors could provide DraftKings with access to new markets and technologies, but it also carries the risk of integration challenges and potential dilution of shareholder value.

The recommended approach carries some risks, including:

  • Increased financial leverage: Excessive debt financing could increase DraftKings' financial risk and make it more vulnerable to economic downturns.
  • Potential for covenant violations: DraftKings must carefully manage its debt obligations to avoid violating loan covenants and triggering potential financial penalties.
  • Conflicts of interest: DraftKings needs to ensure that the private equity firm's interests align with those of the company and its shareholders.

8. Next Steps

To implement the recommended strategy, DraftKings should take the following steps:

  1. Develop a detailed financial model: This model should project the company's future financial performance and assess the impact of different capital structures on its profitability and cash flow.
  2. Engage with potential lenders: DraftKings should begin discussions with potential lenders to secure favorable loan terms and ensure that the debt financing aligns with its overall financial strategy.
  3. Monitor key financial metrics: DraftKings should closely monitor its financial performance and adjust its capital structure as needed to maintain a healthy financial profile.
  4. Communicate effectively with investors: DraftKings should keep its investors informed about its financial strategy and the rationale behind its decisions.

By following these steps, DraftKings can successfully navigate the complex world of capital structure decisions and position itself for continued growth and success in the sports betting and iGaming industry.

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