Corporate Finance: Instructor\'s Manual Applied Corporate Finance

Aswath Damodaran 343

Effect of Ratings Constraints: Disney

Debt Ratio Rating Firm Value

0% AAA $62,279

10% AAA $66,397

20% A- $69,837

30% BB+ $71,239

40% CCC $51,661

50% C $34,969

60% C $30,920

70% C $27,711

80% C $25,105

90% C $22,948

This shows how the constrained optimal is computed. With a BBB constraint,

the constrained optimal is about 25%. With a more rigid constraint, it would be

even lower.

This process can be modified to allow for other constraints. For instance, some

firms do not want their book value debt ratios to rise above a certain level (say,

industry averages). In other cases, existing bond covenants may restrict a

financial ratio from exceeding a specified number.