GETTING

TO THE OPTIMAL
FINANCING MIX
The pathway to the op8mal mix can be rocky.

Set Up and Objective

1: What is corporate finance
2: The Objective: Utopia and Let Down
3: The Objective: Reality and Reaction
The Investment Decision
Invest in assets that earn a return
greater than the minimum acceptable
hurdle rate
Hurdle Rate

4. Define & Measure Risk

5. The Risk free Rate
6. Equity Risk Premiums
7. Country Risk Premiums
8. Regression Betas
9. Beta Fundamentals
10. Bottom-up Betas
11. The "Right" Beta
12. Debt: Measure & Cost
13. Financing Weights

The Financing Decision

Find the right kind of debt for your
firm and the right mix of debt and
equity to fund your operations

Financing Mix
17. The Trade off
18. Cost of Capital Approach
19. Cost of Capital: Follow up
20. Cost of Capital: Wrap up
21. Alternative Approaches
22. Moving to the optimal
Financing Type
23. The Right Financing

Investment Return
14. Earnings and Cash flows
15. Time Weighting Cash flows
16. Loose Ends

36. Closing Thoughts

The Dividend Decision

If you cannot find investments that make
your minimum acceptable rate, return the
cash to owners of your business

Dividend Policy
24. Trends & Measures
25. The trade off
26. Assessment
27. Action & Follow up
28. The End Game

Valuation
29. First steps
30. Cash flows
31. Growth
32. Terminal Value
33. To value per share
34. The value of control
35. Relative Valuation

Now that we have an op8mal.. And an actual..

What next?

At the end of the analysis of nancing mix (using

whatever tool or tools you choose to use), you can
come to one of three conclusions:
The rm has the right nancing mix
It has too liPle 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 rm should

move to its op8mal

Assuming that it does, how should it move to its op8mal,
i.e., a recapitaliza8on or investments.
3

A Framework for GeTng to the Op8mal

Is the actual debt ratio greater than or lesser than the optimal debt ratio?"

Actual > Optimal"

Overlevered"

Actual < Optimal"

Underlevered"

Is the firm under bankruptcy threat?"

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 firm have good "

projects?"
ROE > Cost of Equity"
ROC > Cost of Capital"

Yes"
No"
Take good projects with"
1. Pay off debt with retained"
new equity or with retained" earnings."
earnings."
2. Reduce or eliminate dividends."
3. Issue new equity and pay off "
debt."

Is the firm a takeover target?"

Yes"
Increase leverage"
quickly"
1. Debt/Equity swaps"
2. Borrow money&"
buy shares."

No"
Does the firm 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"

Disney: Applying the Framework

Is the actual debt ratio greater than or lesser than the optimal debt ratio?"

Actual > Optimal"

Overlevered"

Actual < Optimal!

Actual (11.5%) < Optimal (40%)!

Is the firm under bankruptcy threat?"

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 firm have good "

projects?"
ROE > Cost of Equity"
ROC > Cost of Capital"

Yes"
No"
Take good projects with"
1. Pay off debt with retained"
new equity or with retained" earnings."
earnings."
2. Reduce or eliminate dividends."
3. Issue new equity and pay off "
debt."

Is the firm a takeover target?"

No. Large mkt cap & positive
Jensens !

Yes"
Increase leverage"
quickly"
1. Debt/Equity swaps"
2. Borrow money&"
buy shares."

Does the firm 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"

6 Applica8on Test: GeTng to the Op8mal

Based upon your analysis of both the rms capital

structure and investment record, what path would
you map out for the rm?
a.
b.
c.

Immediate change in leverage

Gradual change in leverage
No change in leverage

Would you recommend that the rm change its

nancing mix by
a.
b.

Paying o debt/Buying back equity

Take projects with equity/debt
6

Task
If your rms
actual debt ra8o
is dierent from
its op8mal,
evaluate how
quickly it has to
act & what the
best course of
ac8on is.

Read
Chapter 9