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Strategic Corporate Finance: Applications in Valuation and Capital Structure by Justin Pettit

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CASE STUDY: DOES TECH NEED DEBT?

We highlight many of the principles of today’s optimal capital structure with a case study for the technology sector. Technology faces many of the issues with which corporations are struggling but in more extreme proportions. The appeal of low interest rates raises the question of whether additional debt would be more appropriate. Large and growing cash positions raise questions of optimal cash for operating liquidity and forms of secondary liquidity. Dividends and buybacks are now a perennial Board of Directors agenda item in technology.

Though a case for a modest increase in financial leverage may exist among the larger, more mature technology companies, the case is more compelling—and the value proposition far greater—for technology companies to optimize (i.e., in most cases, reduce) their cash balances and investigate alternative means for secondary liquidity to buffer event risk (as we outline in our chapter on strategic risk management). Share repurchases and, in some cases, special dividends represent the most efficient mechanism to reallocate this capital to more productive and profitable uses. (See Chapter 8 for more on dividends and buybacks.)

WACC Minimization Does Not Equal Value Maximization

Intrinsic value purists routinely assume that the optimal capital structure puzzle is an exercise in WACC minimization. The premise is that since firm value is the present value of all future cash flows, it stands to reason that value is maximized ...

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