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Subject:  Re: Question for Hewitt about WACC Date:  2/24/2008  11:49 PM
Author:  TMFKMHinson Number:  1437 of 1817

Hi Joe...

So, my point is that a company can not only use debt responsibly, it may in fact be irresponsible to ignore the option of using debt as *some* portion of invested capital, as long as the return on that capital is greater than it's cost, and by taking on some debt, that cost is reduced, since as you say, equity is more expensive.

I don't disagree with this statement, and I think your home mortgage is a great analogy. I might not go so far as to say it's "irresponsible," but even that could be debated depending on the scenario. I said that I consider this tradeoff a conundrum, but that varies to some degree depending on the company I suppose. In the link you provide, for example, it's probably quite appropriate for Disney to use leverage and attempt to sit in that sweet spot seeing as they have a relatively predictable business at this point. Select Comfort, however, is an example of a company that levered up... put the proceeds into share repurchases between $15-20, and then the wheels fell off. Their balance sheet has deteriorated considerably, and they'd be in a much stronger position to weather their current trouble if they'd just stayed debt free. On the flip side, only time will tell, but it's my hunch (based on my own valuation) that Panera is going about it very appropriately. The debt they took on in November was used to repurchase shares at very good values in late December and early January... the debt load is modest, and they're able to easily service it while still funding growth with free cash. We'll know in a few years, but my opinion is that this was an opportune time for them to lever up, and given the uncertainty of a young, fast growing business like theirs, I'm glad they stayed out of the sweet-spot and maintained the debt-free balance sheet for the last nine years so they were able to take advantage of their current market valuation to return more capital to shareholders by taking on a modest amount of debt. They're still probably far from that sweet-spot, but it's too unpredictable of a business to be in I think, and their cash requirements are too significant to fully lever up today. The headroom is nice if we hit a prolonged slowdown.

Anyway... last post for the day... I spend too much time on the computer during the week to spend this much time prattling on over the weekend. :)

Later on...
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