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A Rose by Any Other Name

In: Business and Management

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Corporate Finance Lecture Note Packet 2 Capital Structure, Dividend Policy and Valuation

B40.2302

Aswath Damodaran

Aswath Damodaran!

1!

Capital Structure: The Choices and the Trade off

Neither a borrower nor a lender be

Someone who obviously hated this part of corporate finance

Aswath Damodaran!

2!

First Principles

Aswath Damodaran!

3!

The Choices in Financing



There are only two ways in which a business can make money.

• The first is debt. The essence of debt is that you promise to make fixed payments in the future (interest payments and repaying principal). If you fail to make those payments, you lose control of your business.

• The other is equity. With equity, you do get whatever cash flows are left over after you have made debt payments.

Aswath Damodaran!

4!

Global Patterns in Financing…

Aswath Damodaran!

5!

And a much greater dependence on bank loans outside the US…

Aswath Damodaran!

6!

Assessing the existing financing choices: Disney, Aracruz and Tata Chemicals

Aswath Damodaran!

7!

Financing Choices across the life cycle

Revenues $ Revenues/ Earnings Earnings

Time

External funding needs

High, but constrained by infrastructure

High, relative to firm value.

Moderate, relative to firm value.

Declining, as a percent of firm value

Low, as projects dry up.

Internal financing

Negative or low Owner’s Equity Bank Debt Stage 1 Start-up

Negative or low

Low, relative to funding needs Common stock Warrants Convertibles Stage 3 High Growth

High, relative to funding needs Debt

More than funding needs

External Financing Growth stage

Venture Capital Common Stock Stage 2 Rapid Expansion

Retire debt Repurchase stock Stage 5 Decline

Stage 4 Mature Growth

Aswath Damodaran!

Financing…...

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