debtdesign - Getting to the Optimal: Timing and Financing...

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Aswath Damodaran 93 Getting to the Optimal: Timing and Financing Choices
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Aswath Damodaran 94 Big Picture…
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Aswath Damodaran 95 Now that we have an optimal. . And an actual. . What next? At the end of the analysis of Fnancing mix (using whatever tool or tools you choose to use), you can come to one of three conclusions: The Frm has the right Fnancing mix It has too little debt (it is under levered) It has too much debt (it is over levered) The next step in the process is Deciding how much quickly or gradually the Frm should move to its optimal Assuming that it does, the right kind of Fnancing to use in making this adjustment
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Aswath Damodaran 96 A Framework for Getting to the Optimal Is the actual debt ratio greater than or lesser than the optimal debt ratio? Actual > Optimal Overlevered Actual < Optimal Underlevered Is the frm under bankruptcy threat? Is the frm a takeover target? Yes No Reduce Debt quickly 1. Equity For Debt swap 2. Sell Assets; use cash to pay oFF debt 3. Renegotiate with lenders Does the frm have good projects? ROE > Cost oF Equity ROC > Cost oF Capital Yes Take good projects with new equity or with retained earnings. No 1. Pay oFF debt with retained earnings. 2. Reduce or eliminate dividends. 3. Issue new equity and pay oFF debt. Yes No Does the frm have good projects? ROE > Cost oF Equity ROC > Cost oF Capital Yes Take good projects with debt. No Do your stockholders like dividends? Yes Pay Dividends No Buy back stock Increase leverage quickly 1. Debt/Equity swaps buy shares.
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Aswath Damodaran 97 Disney: Applying the Framework Is the actual debt ratio greater than or lesser than the optimal debt ratio? Actual > Optimal Overlevered Actual < Optimal Actual (26%) < Optimal (40%) Is the frm under bankruptcy threat? Is the frm a takeover target? Yes No Reduce Debt quickly 1. Equity For Debt swap 2. Sell Assets; use cash to pay oFF debt 3. Renegotiate with lenders Does the frm have good projects? ROE > Cost oF Equity ROC > Cost oF Capital Yes Take good projects with new equity or with retained earnings. No 1. Pay oFF debt with retained earnings. 2. Reduce or eliminate dividends. 3. Issue new equity and pay oFF debt. Yes No. Large mkt cap & positive Jensen ` s α Does the frm have good projects? ROE > Cost oF Equity ROC > Cost oF Capital Yes. ROC > Cost oF capital Take good projects With debt. No Do your stockholders like dividends? Yes Pay Dividends No Buy back stock Increase leverage quickly 1. Debt/Equity swaps buy shares.
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Aswath Damodaran 98 Application Test: Getting to the Optimal Based upon your analysis of both the Frm ` s capital structure and investment record, what path would you map out for the Frm? Immediate change in leverage
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debtdesign - Getting to the Optimal: Timing and Financing...

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