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The Investment DecisionInvest in assets that earn a

return greater than the

minimum acceptable hurdlerate

The Financing DecisionFind the right kind of debtfor your firm and the rightmix of debt and equity to

fund your operations

The Dividend DecisionIf you cannot find investments

that make your minimum

acceptable rate, return the cashto owners of your business

The hurdle rateshould reflect theriskiness of theinvestment andthe mix of debt

and equity usedto fund it.

The returnshould reflect themagnitude andthe timing of the

cashflows as welll

as all side effects.

The optimalmix of debtand equity

maximizes firm

value

The right kindof debt

matches thetenor of your

assets

How muchcashyou can

returndepends upon

current &

potentialinvestment

opportunities

How you chooseto return cash tothe owners will

depend onwhether they

prefer dividendsor buybacks

Maximize the value of the business (firm)

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Is the actual debt ratio greater than or lesser than the optimal debt ratio?

Actual > OptimalOverlevered

Actual < OptimalUnderlevered

Is the firm under bankruptcy threat? Is the firm a takeover target?

Yes No

Reduce Debt quickly1. Equity for Debt swap2. Sell Assets; use cashto pay off debt3. Renegotiate with lenders

Does the firm have goodprojects?ROE > Cost of EquityROC > Cost of Capital

Yes

Take good projects withnew equity or with retainedearnings.

No

1. Pay off debt with retainedearnings.2. Reduce or eliminate dividends.3. Issue new equity and pay offdebt.

Yes No

Does the firm have goodprojects?ROE > Cost of EquityROC > Cost of Capital

Yes

Take good projects withdebt.

No

Do your stockholders like

dividends?

YesPay Dividends No

Buy back stock

Increase leveragequickly1. Debt/Equity swaps2. Borrow money&buy shares.

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Is the actual debt ratio greater than or lesser than the optimal debt ratio?

Actual > OptimalOverlevered

Actual < OptimalActual (11.58%) < Optimal (40%)

Is the firm under bankruptcy threat? Is the firm a takeover target?

Yes No

Reduce Debt quickly1. Equity for Debt swap2. Sell Assets; use cashto pay off debt3. Renegotiate with lenders

Does the firm have goodprojects?ROE > Cost of EquityROC > Cost of Capital

Yes

Take good projects withnew equity or with retainedearnings.

No

1. Pay off debt with retainedearnings.2. Reduce or eliminate dividends.3. Issue new equity and pay offdebt.

YesNo. Large mkt cap & positiveJensens

Does the firm have goodprojects?ROE > Cost of EquityROC > Cost of Capital

Yes. ROC > Cost of capital

Take good projects

With debt.

No

Do your stockholders like

dividends?

YesPay Dividends No

Buy back stock

Increase leveragequickly1. Debt/Equity swaps2. Borrow money&buy shares.

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