Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

(Hop HipldF0AV) #1

ormoregenerally,increaseitsfirmvaluebychangingboth
financing mix and type.


1.Make products/serviceslessdiscretionary.Theoperating
riskofafirmisadirectfunctionoftheproductsorservicesit
providesandthedegreetowhichtheseproducts/servicesare
discretionaryto its customers.Themorediscretionarythey
are, the greater the operating risk faced by the firm.
Consequently, firms can reduce their operating risk by
makingtheirproductsandserviceslessdiscretionarytotheir
customers.Advertisingclearlyplays arole,but coming up
withnewusesforaproduct/servicemaybeanotherwayto
achieve this.



  1. Reduceoperating leverage. Theoperating leverageof a
    firmmeasurestheproportionofitscoststhatarefixed.Other
    thingsremainingequal,thegreatertheproportionofthecosts
    ofafirmthatarefixed,themorevolatileitsearningswillbe
    andthehigheritscostofequity/capitalwillbe.Reducingthe
    proportionofthecoststhatarefixedwillmakeafirmless
    risky and reduce its cost of capital.
    4


3.Changefinancingmix.Debtisalwayscheaperthanequity,
partlybecauselendersbearlessriskthanequityinvestorsand
partly because of the tax advantage associated with debt.
Offsettingthis advantageisthe factthatborrowing money
increasestheriskandthecostofbothdebt(byincreasingthe
probabilityofbankruptcy)andequity(bymakingearningsto
equityinvestorsmorevolatile).Theneteffectwilldetermine
whether the cost of capital will increase or decrease if the firm
takes on more debt. As noted in Chapter 6, one way of

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