Quantitative Corporate Finance

You are Here: QCF » Cookbook » Debt Capacity

Optimal Capital Structure with Business Disruption Costs

by 2 Comments

In an earlier post we showed that, for a tax-paying firm, WACC is always a declining function of leverage.  If firm value is an inverse function of WACC, this suggests funding operations with 100% debt.

In fact we observe that firm value is concave in leverage and appears to peak when there is some equity in the capital structure.  We’re forced to conclude that firm value isn’t solely a function of WACC, but instead varies in a more complicated fashion with leverage.  In this post we’ll review one theory that explains this, and which can guide us in divining an “optimal” capital structure. [Read more…]

Calculate WACC With Debt Beta

by 20 Comments

Calculating WACC correctly should preclude its use to optimize capital structure.  In this post we’ll see why.

Traditional WACC Calculation

There was a time when WACC was used to find an “optimal capital structure”, which meant a debt/equity ratio that minimized the cost of capital.  Charts like this were part of the argument:

[Read more…]

Consider Asset Duration Matching

by Leave a Comment

Separately from overall debt capacity, debt structure reflects specific choice of capital structure instruments.  We address the goal of maximizing shareholder value in two ways:

  • In good times, minimize the expected funding costs of the firm
  • In bad times, minimize the costs of financial distress

In this post we consider duration matching, which clients occasionally propose. [Read more…]