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Aswath Damodaran Session 19 (MBA): APV and Relative Assessment – Optimal Financing Mix

Aswath Damodaran Session 19 (MBA): APV and Relative Assessment – Optimal Financing Mix

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Published on Apr 13, 2016

In this class, we continued our discussion of the cost of capital approach to optimizing debt ratios by looking at the determinants of the optimal. In particular, it was differences in tax rates, cash flows (as a percent of value) and risk that determined why some companies have high optimal debt ratios and why some have low or no debt capacity. We then looked at the Adjusted Present Value (APV) approach to analyzing the effect of debt. In particular, this approach looks at the primary benefit of debt (taxes) and the primary costs (expected bankruptcy) and netted out the difference from the unlevered firm value. If you are interested in trying this out, I have attached an APV spreadsheet which you can use on your company (with your own judgment call on what the indirect bankruptcy cost is as a percent of value). We closed the discussion of optimal by noting that many firms decide how much to borrow by looking their peer group and argued that if you decide to go this route, you should use more of the information than just the average. If you can plug in the numbers for the optimal debt ratio into the optimal capital structure, it would be a giant step forward on your project.
Slides:
http://www.stern.nyu.edu/~adamodar/po...
APV Spreadsheet: http://www.stern.nyu.edu/~adamodar/pc...
Post class test: http://www.stern.nyu.edu/~adamodar/pd...
Post class test solution: http://www.stern.nyu.edu/~adamodar/pd...

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Please note that I do not read comments posted here, nor respond to messages here. I don't have the time. If you want my attention, you must seek it directly at my blog. Aswath Damodaran is the Kerschner Family Chair Professor of Finance at the Stern School of Business at New York University. He teaches the corporate finance and equity valuation courses in the MBA program. He received his MBA and Ph.D from the University of California at Los Angeles. His research interests lie in valuation, portfolio management and applied corporate finance. He has written three books on equity valuation (Damodaran on Valuation, Investment Valuation, The Dark Side of Valuation) and two on corporate finance (Corporate Finance: Theory and Practice, Applied Corporate Finance: A User’s Manual). He has co-edited a book on investment management with Peter Bernstein (Investment Management) and has a book on investment philosophies (Investment Philosophies). His newest book on portfolio management is titled Investment Fables and was released in 2004. His latest book is on the relationship between risk and value, and takes a big picture view of how businesses should deal with risk, and was published in 2007. He was a visiting lecturer at the University of California, Berkeley, from 1984 to 1986, where he received the Earl Cheit Outstanding Teaching Award in 1985. He has been at NYU since 1986, received the Stern School of Business Excellence in Teaching Award (awarded by the graduating class) in 1988, 1991, 1992, 1999, 2001, 2007, 2008 and 2009, and was the youngest winner of the University-wide Distinguished Teaching Award (in 1990). He was profiled in Business Week as one of the top twelve business school professors in the United States in 1994.

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