Hitchner’s ‘myth busters’ tackle two more issues

BVWireIssue #256-2
January 17, 2024

valuation methods & approaches
beta, debt, shareholder equity

Jim Hitchner (Financial Valuation Advisors) and his team of fellow AICPA BV Hall of Fame alumni have taken on two more BV myths in his December issue of Hardball With Hitchner. Myth No. 6 on their list is this: “There are supportable methods for determining the optimal capital structure of a business.” He goes through some common methods for doing this, such as taking an average of the capital structures of guideline public companies, and concludes that these methods “are not always valid or supportable.”

Can be done: BVWire points out that, while it is true that there is no way to calculate the capital structure precisely that will maximize firm value, firms routinely determine a target capital structure by looking at a variety of factors (too many to discuss here). Once they determine the approximate proportion of debt and equity that is best given their circumstances, investment decisions are made accordingly, i.e., investments are financed in roughly the same proportion. Using these same factors (Hitchner discusses a few of them), the analyst can provide some level of support for an estimate of an optimal capital structure.

On to Myth No. 7, which is this: “The Hamada formula is the correct method to unlever and relever betas to account for differences in capital structures.” The formula is commonly used when valuing a company using public-company betas, which must be adjusted to the capital structure of the subject company. He cites several sources and texts in busting this myth, but he points out that it “can still be used in many instances.”

The other members of the myth-busting group are: Harold Martin (Keiter), Ron Seigneur (Seigneur Gustafson LLP), Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos PC), Ed Dupke (Dupke Consulting LLC), and Jim Alerding (Alerding Consulting LLC).

Hardball With Hitchner is a monthly publication. For subscription information, click here.

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