Aswath Damodaran 348
Analyzing Companies after Abnormal Years
! The operating income that should be used to arrive at an optimal debt ratio is
a “normalized” operating income
! A normalized operating income is the income that this firm would make in a
normal year.
- For a cyclical firm, this may mean using the average operating income over an
economic cycle rather than the latest year’s income
- For a firm which has had an exceptionally bad or good year (due to some firm-
specific event), this may mean using industry average returns on capital to arrive at
an optimal or looking at past years
- For any firm, this will mean not counting one time charges or profits
Since the optimal debt ratio for a firm is a ratio that you expect the firm to
sustain in the long term, you need to have a measure of what the sustainable
operating income in the long term is.
