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The foremost principles the survey participants identified were maintaining financial flexibility and ensuring long term survivability (which can be construed as avoiding bankruptcy). Surprisingly few managers attached much importance to maintaining comparability with other firms in their industries or maintaining a high debt rating.

Illustration 7.4: Evaluating the Debt Trade off - Disney, Aracruz and Bookscape

In table 7.5, we summarize our views on the potential benefits and costs to using debt, instead of equity, at Disney, Aracruz and Bookscape.

Table 7.5: The Debt Equity Trade Off: Disney, Aracruz and Bookscape

Item

Disney

Aracruz

Bookscape

Tax Benefits

Significant. The firm has a marginal tax rate of 35%. It does have large depreciation tax shields.

Significant. The firm has a marginal tax rate of 34%, as well. It does not have very much in non-interest tax shields.

Significant. The owners of Bookscape face a 40% tax rate. By borrowing money, the income that flows through to the investor can be reduced.

Added Discipline

Benefits will be high, since managers are not large stockholders.

Benefits are smaller, since the voting shares are closely held by insiders.

Benefits are non-existent. This is a private firm.

Bankruptcy Cost

Movie and broadcasting businesses have volatile earnings. Direct costs of bankruptcy are likely to be small, but indirect costs can be significant.

Variability in paper prices makes probability of bankruptcy high. Direct and indirect costs of bankruptcy likely to be moderate.

Costs may be small but the owner has all of his wealth invested in the firm. Since his liability, in the event of failure, is not limited, the costs will viewed as very large.

Agency Costs

High. While theme park assets are tangible and fairly liquid, is is much more difficult to monitor movie and broadcasting businesses.

Low. Assets are tangible and liquid.

Low. Prime asset is leasehold, which is liquid.

Flexibility Needs

Low in theme park business but high in media businesses because technological change

Low. Business is mature and investment needs are well established.

Low. Book store is established and additional investments are limited.

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