638  Capital Structure, Dividends, and Share Repurchases
and investments in its own direct-to-customer channels. Compared with the 
base case, annual EBITDA will be around $200 million lower and capital ex-
penditures around $50 million higher by 2024. Including an additional $500 
million spent on acquisitions, MaxNV will generate about $1.0 billion less in 
after-tax cash flow from operations than in the base case. The second down-
side scenario sees this competitive disruption aggravated by a major economic 
downturn, depressing revenues and earnings across the sector. EBITDA will 
now be $300 million lower in 2024 compared with the base case.
For companies in industries where price and volume risks are greater, such 
as commodities, you might replace the use of scenarios with a more sophis-
ticated approach: modeling future cash flows by using stochastic simulation 
techniques to estimate the probability of financial distress at the various debt 
levels.
Step 2: Develop a Capital Structure Target
Next, we set a target credit rating and estimated the corresponding cover-
age ratios to develop a capital structure target. Although MaxNV’s operating 
performance is normally stable (as it is with most branded-consumer-goods 
players), we targeted the high end of a BBB credit rating because of the com-
pany’s currency risk as an exporter. We translated the target credit rating to 
a target net-debt-to-EBITDA coverage ratio of 2.5 times.5 This coverage ratio 
was applied in all scenarios.
Step 3: Estimate Surplus or Deficit
Based on the target coverage ratio and projections of operating cash flows, 
we estimated MaxNV’s target capital structure and cash surpluses (or defi-
cits) for each of the next five years. The detailed calculations are shown in 
Exhibit 33.3. For example, in the base case scenario, $1.0 billion of EBITDA 
in 2020 and a target coverage ratio of 2.5 times result in a target debt level 
of $2.5 billion for the end of the year. Starting with $2.8 billion of debt at the 
beginning of 2020, deducting $513 million of free cash flow from operations 
and adding $105 million of after-tax interest expenses leave MaxNV with 
surplus cash of $108 million that could be distributed to shareholders in 2020. 
With the same calculation through the remaining years of the forecast, the 
cumulative cash surplus for distribution amounts to around $2.7 billion over 
the five-year period. Exhibit 33.3 also shows the cumulative surplus for the 
competitive-disruption scenario ($1.2 billion) and the economic-downturn 
scenario ($552 million).
5 As discussed later in this chapter, empirical analysis shows that approximate credit ratings can be 
estimated well with three factors: industry, size, and interest coverage.

A Four-Step Approach  639
For both downside scenarios, a cash deficit occurs in some individual years. 
For these years, MaxNV could decide to simply exceed target debt levels and 
return to target levels later. Alternatively, it could build up excess debt capac-
ity in prior years to ensure target debt levels are met in each year. Of course, if 
a cumulative deficit occurred for the entire planning horizon, MaxNV would 
need to consider issuing equity or find other financing opportunities, such as 
additional divestitures or cost savings.
EXHIBIT 33.3  MaxNV: Estimates of Cash Surplus and Deficit
$ million
  Projections 
Cumulative, 
2020–2024
Base case scenario
2020
2021
2022
2023
2024
EBITDA1
1,000
1,050
1,103
1,158
1,216
5,526
Net debt, beginning of year
(2,800)
(2,500)
(2,625)
(2,756)
(2,894)
(2,800)
FCF2 from operations
513
573
636
625
666
3,012
Interest, after-tax
(105)
(94)
(98)
(103)
(109)
(509)
Add: Target net debt, end of year @ 2.5× EBITDA1
2,500
2,625
2,756
2,894
3,039
3,039
Cash surplus paid out to equity (cash deficit funded with debt)
108
604
668
659
702
2,742
Target net debt EOY @ 2.5× EBITDA
(2,500)
(2,625)
(2,756)
(2,894)
(3,039)
Excess debt
–
–
–
–
–
Cash deficit funded with debt
(2,500)
(2,625)
(2,756)
(2,894)
(3,039)
Competitive-disruption scenario
EBITDA1
1,000
1,050
1,003
958
1,016
5,026
Net debt, beginning of year
(2,800)
(2,500)
(2,625)
(2,713)
(2,394)
(2,800)
FCF2 from operations
513
523
11
450
491
1,987
Interest, after-tax
(105)
(94)
(98)
(102)
(90)
(489)
Add: Target net debt, end of year @ 2.5× EBITDA2
2,500
2,625
2,506
2,394
2,539
2,539
Cash surplus paid out to equity (cash deficit funded with debt)
108
554
(207)
29
546
1,237
Target net debt, end of year
(2,500)
(2,625)
(2,506)
(2,394)
(2,539)
Excess debt
–
–
(207)
–
–
Net debt, end of year
(2,500)
(2,625)
(2,713)
(2,394)
(2,539)
Economic-downturn scenario
EBITDA1
1,000
950
853
858
916
4,576
Net debt, beginning of year
(2,800)
(2,500)
(2,375)
(2,604)
(2,351)
(2,800)
FCF2 from operations
513
423
(139)
350
391
1,537
Interest, after-tax
(105)
(94)
(89)
(98)
(88)
(474)
Add: Target net debt, end of year @ 2.5× EBITDA2
2,500
2,375
2,131
2,144
2,289
2,289
Cash surplus paid out to equity (cash deficit funded with debt)
108
204
(472)
(207)
240
552
Target net debt, end of year
(2,500)
(2,375)
(2,131)
(2,144)
(2,289)
Excess debt
–
–
(472)
(207)
–
Net debt, end of year
(2,500)
(2,375)
(2,604)
(2,351)
(2,289)
1 Earnings before interest, taxes, depreciation, and amortization.
2 Future cash flows.