Quantitative Corporate Finance

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Optimal Capital Structure with Business Disruption Costs

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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…]

The Economic Irrelevance of Distribution Form

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A recent article in the Economist suggests that managers with exposure to their firm’s share price would benefit by reducing dividends and instead buying back shares.  From a strictly economic point of view, we don’t see the difference. [Read more…]

Calculate WACC With Debt Beta

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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:

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Get Company Fundamental Data

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There are a variety of online sources of company fundamental data (historical financial filings).  The easiest and most reliable are the paid services, such as Compustat, Capital IQ, or Bloomberg.

In this recipe we show how to use Yahoo Finance’s “Stock Market Functions” Excel add-in, which consolidates references to a variety of company and market data from several online sources. [Read more…]