n To the degree that these assumptions are wrong our conclusions can also be

N to the degree that these assumptions are wrong our

This preview shows page 115 - 122 out of 239 pages.

n To the degree that these assumptions are wrong, our conclusions can also be wrong. n One way to gain confidence in the conclusions is to check to see how sensitive the decision measure (NPV, IRR..) is to changes in key assumptions.
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Aswath Damodaran 116 Side Costs and Benefits n Most projects considered by any business create side costs and benefits for that business. n The side costs include the costs created by the use of resources that the business already owns (opportunity costs) and lost revenues for other projects that the firm may have. n The benefits that may not be captured in the traditional capital budgeting analysis include project synergies (where cash flow benefits may accrue to other projects) and options embedded in projects (including the options to delay, expand or abandon a project). n The returns on a project should incorporate these costs and benefits.
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Aswath Damodaran 117 Back to 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.
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Aswath Damodaran 118 Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran Stern School of Business
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Aswath Damodaran 119 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.
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Aswath Damodaran 120 What is debt? n General Rule: Debt generally has the following characteristics: Commitment to make fixed payments in the future The fixed payments are tax deductible Failure to make the payments can lead to either default or loss of control of the firm to the party to whom payments are due.
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Aswath Damodaran 121 What would you include in debt?
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