Live Case Study Mechanics of Moving to the Optimal

Objective: To determine whether your firm should move to its optimal mix, and if so, how, and to analyze the right type of debt for your firm.

Key Questions:

• If your firm's actual debt ratio is different from its "recommended" debt ratio, how should they get from the actual to the optimal? In particular, a. should they do it gradually over time or should they do it right now?

b. should they alter their existing mix (by buying back stock or retiring debt), should they invest in new projects with debt or equity or should they change how much they return to stockholders?

• What type of financing should this firm use? In particular, a. should the financing be short term or long term?

b. what currency should it be in?

c. what special features should the financing have?

Framework for Analysis

1. The Immediacy Question

• If the firm is under levered, does it have the characteristics of a firm that is a likely takeover target? (Target firms in hostile takeovers tend to be smaller, have poorer project and stock price performance than their peer groups and have lower insider holdings)

• If the firm is over levered, is it in danger of bankruptcy? (Look at the bond rating, if the company is rated. A junk bond rating suggests high bankruptcy risk.)

2. Alter Financing Mix or Take Proejcts

• What kind of projects does this firm expect to have? Can it expect to make excess returns on these projects? (Past project returns is a reasonable place to start - see the section under investment returns)

• What type of stockholders does this firm have? If cash had to be returned to them, would they prefer dividends or stock buybacks? (Again, look at the past. If the company has paid high dividends historically, it will end up with investors who like dividends) 3. Financing Type

• How sensitive has this firm's value been to changes in macro economic variables such as interest rates, currency movements, inflation and the economy?

• How sensitive has this firm's operating income been to changes in the same variables?

• How sensitive is the sector's value and operating income to the same variables?

• What do the answers to the last 3 questions tell you about the kind of financing that this firm should use?

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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