640  Capital Structure, Dividends, and Share Repurchases
Step 4: Decide on a Surplus Payout and Deficit Financing
The final step is to decide what payout and financing over the ensuing years 
will move the company to its target capital structure. Consider Exhibit 33.4, 
which summarizes the cumulative cash flows associated with the four steps 
for each of the three scenarios. Over the next five years under all scenarios, 
MaxNV can easily return $450 million ($90 million per year) in the form of reg-
ular dividends. Taking a less conservative stance, MaxNV could even consider 
a dividend payout of about $1 billion ($200 million per year), which it would 
need to cut back in the case of a downturn scenario. If the new dividend pay-
out represents an increase from current levels, its announcement would send 
a strong signal to the stock market that MaxNV is confident about its business 
outlook and its ability to sustain this dividend level.
EXHIBIT 33.4  MaxNV: Deciding on Payout
$ million
Cumulative cash flows, 2020–2024
Base case
Competitive disruption
Economic downturn
Scenario
Disruption 
impact
Scenario
Downturn 
impact
Scenario
Step 1
Project operational cash flows
EBITDA1
5,526
(500)
5,026
(450)
4,576
Capital expenditures
(553)
(200)
(753)
(753)
Acquisitions
(1,000)
(500)
(1,500)
(1,500)
Divestments
75
50
125
125
Operating taxes
(1,036)
125
(911)
(911)
Future cash flow from operations
3,012
(1,025)
1,987
(450)
1,537
Step 2
Develop capital structure target
Net debt/EBITDA target
2.5
2.5
2.5
Step 3
Estimate surplus (deficit)
Net debt, beginning of year 2020
(2,800)
(2,800)
(2,800)
Future cash flow from operations
3,012
1,987
1,537
Interest, after taxes
(509)
(489)
(474)
Add: Target net debt, end of year 2024 @ 2.5× EBITDA
3,039
2,539
2,289
Cash surplus paid out to equity
2,742
1,237
552
Step 4
Decide on payout (financing)
Dividend payout
450
450
450
Share buybacks
2,292
787
102
Cash surplus paid out to equity
2,742
1,237
552
Dividend per year, average
90
90
90
Buyback per year, average
458
157
20
1 Earnings before interest, taxes, depreciation, and amortization.

Setting a Target Capital Structure  641
Any remaining cash for each of the scenarios could be returned to share-
holders over the next several years through share repurchases or extraordi-
nary dividends. The amount based on a conservative $450 million dividend 
payout would be almost $2.3 billion under the base case, about $800 million 
under the disruption scenario, and about $100 million under the downturn 
scenario. Like a dividend increase, share repurchases and extraordinary div-
idends signal confidence, but they have the advantage that investors won’t 
see them as a commitment to additional payouts in future years. This gives 
MaxNV valuable flexibility to change the amount of cash paid out over the 
next years in accordance with business results and market developments. 
It might increase its payout, for example, as management becomes more 
certain that the company will achieve the base-case projection, or it could 
withhold most of the cash as long as it considers a downturn scenario more 
likely.
Setting a Target Capital Structure
Financing instruments vary widely, offering many options, from traditional 
common equity and straight debt to more exotic instruments, among them 
convertible preferred equity and convertible and commodity-linked debt. But 
the essential choice remains between straight debt and common equity. In this 
balancing act, tilting toward equity gives managers more flexibility to work 
through unexpected downturns or take advantage of unforeseen opportuni-
ties, such as acquisitions. Taking on more debt delivers higher efficiency from 
tax benefits and enhances management discipline over investment spending.
Empirical research shows that companies actively manage their capital 
structure around certain leverage boundaries.6 They make adjustments to re-
gain their target capital structure after they have missed it for one or two 
years, rather than immediately after each change in leverage. Continual ad-
justment would be impractical and costly, due to share price volatility and 
transaction costs.7
Fundamental Debt/Equity Trade-Offs
For decades, academic researchers have sought to learn which debt-to-equity 
ratio represents the best trade-off between flexibility and efficiency and maxi-
mizes value for shareholders. Unfortunately, a clear model remains elusive.8
6 P. Marsh, “The Choice between Equity and Debt: An Empirical Study,” Journal of Finance 37, no. 1 
(1982): 121–144.
7 See, for example, M. Leary and M. Roberts, “Do Firms Rebalance Their Capital Structures?” Journal of 
Finance 60, no. 6 (2005): 2575–2619.
8 For an overview, see Barclay and Smith, “The Capital Structure Puzzle.”