Brcapstr - Aswath Damodaran 1 Corporate Finance: Capital...

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Unformatted text preview: Aswath Damodaran 1 Corporate Finance: Capital Structure and Financing Decisions Aswath Damodaran Stern School of Business Aswath Damodaran 2 First Principles n Invest in projects that yield a return greater than the minimum acceptable hurdle rate . The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners funds (equity) or borrowed money (debt) Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects. n Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. n If there are not enough investments that earn the hurdle rate, return the cash to stockholders. The form of returns - dividends and stock buybacks - will depend upon the stockholders characteristics . Objective: Maximize the Value of the Firm Aswath Damodaran 3 The Objective in Decision Making n In traditional corporate finance, the objective in decision making is to maximize the value of the firm . n A narrower objective is to maximize stockholder wealth . When the stock is traded and markets are viewed to be efficient, the objective is to maximize the stock price . n All other goals of the firm are intermediate ones leading to firm value maximization, or operate as constraints on firm value maximization. Aswath Damodaran 4 The Classical Objective Function STOCKHOLDERS Maximize stockholder wealth Hire & fire managers- Board- Annual Meeting BONDHOLDERS Lend Money Protect bondholder Interests FINANCIAL MARKETS SOCIETY Managers Reveal information honestly and on time Markets are efficient and assess effect on value No Social Costs Costs can be traced to firm Aswath Damodaran 5 What can go wrong? STOCKHOLDERS Managers put their interests above stockholders Have little control over managers BONDHOLDERS Lend Money Bondholders can get ripped off FINANCIAL MARKETS SOCIETY Managers Delay bad news or provide misleading information Markets make mistakes and can over react Significant Social Costs Some costs cannot be traced to firm Aswath Damodaran 6 When traditional corporate financial theory breaks down, the solution is: n To choose a different mechanism for corporate governance n To choose a different objective n To maximize stock price, but reduce the potential for conflict and breakdown: Making managers (decision makers) and employees into stockholders By providing information honestly and promptly to financial markets Aswath Damodaran 7 An Alternative Corporate Governance System n Germany and Japan developed a different mechanism for corporate governance, based upon corporate cross holdings....
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Brcapstr - Aswath Damodaran 1 Corporate Finance: Capital...

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