Aswath Damodaran 371
Applying the Regression
Lets check whether we can use this regression. Disney had the following values
for these inputs in 1996. Estimate the optimal debt ratio using the debt
regression.
Effective Tax Rate = 34. 76 %
Closely held shares as percent of shares outstanding = 2. 2 %
Capital Expenditures as fraction of firm value = 2. 09 %
EBITDA/Value = 7. 67 %
Optimal Debt Ratio
= 0. 0488 + 0. 810 ( ) – 0. 304 ( ) + 0. 841 ( ) – 2. 987 ( )
What does this optimal debt ratio tell you?
Why might it be different from the optimal calculated using the weighted
average cost of capital?
Plugging in the values for Disney yields the following optimal debt ratio:
DFRDisney= 0 .0488 + 0.810 (0.3476) – 0 .304 (0.022) + 0.841
(.0767) – 2 .987 (.0209)
= 0.3257 or 32.57%
Based upon the debt ratios of other firms in the market and Disney’s financial
characteristics, we would expect Disney to have a debt ratio of 32.57%. Since its
actual debt ratio is 21.02%, Disney is under levered.
It may be different from the optimal because it is based upon the assumption
that firms, on average, get their debt ratios right. If most firms are under levered,
for instance, you will get a lower predicted value from the regression than for a
cost of capital approach.
