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.
- 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