MICROSOFT (present day)

1. Intrinsic approaches

a. As a starting point, estimate the current debt ratio for the firm and the cost of capital at that debt ratio (see chapter 4).

b. Estimate your costs of debt, equity and capital as your debt ratio changes in the firm. That will require you to estimate the beta and synthetic rating at each debt ratio.

c. Examine how the optimal debt ratio changes, as you change key inputs into the analysis (both micro and macro), keeping in mind the volatility of earnings in your companys history and the sector that it operates in. You may also want to incorporate indirect bankruptcy costs into your assessments.

d. If you can try the adjusted present value approach, where you consider the tax benefits from debt and weigh them off against expected bankruptcy costs. Compare the optimal debt ratio that you get, using this approach, to the one that you get with the cost of capital approach.

e. Make a judgment on your optimal debt ratio. In making this judgment, you can start with your cost of capital assessments but you should also consider whether the payoff from moving to the optimal justifies the risk in doing so. Also, estimate the value of the business and the per share value, if you move to the optimal