Estimating the Value of Financial Flexibility
Originally published: 28/06/2016 10:18
Publication number: ELQ-99970-1
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Estimating the Value of Financial Flexibility

Calculate the value of financial flexibility

This model calculates the value of financial flexibility on an annualized basis. It an be used to determine if firms should maintain excess debt capacity.

The user has to input the following variables
1. Expected annual reinvestment needs as percent of firm value
2. Variance in annual expected reinvestment needs
3. Annual Reinvestment Needs that can be financed without financial flexibility (from internal funds or accessible external funds)
4. Riskless interest rate that corresponds to the life of the option
5. Current Cost of Capital
6. Excess Returns earned on Projects (ROC - Cost of Capital)

Note: this model is being shared with the authorization of Professor Aswath Damodaran from NYU Stern Business School (

This Best Practice includes
1 Excel Model File

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Further information

- Stock Price
- Strike Price
- Expiration (in years)
- Annual Excess Return
- Maximum Flexibility
- T.Bond rate
- Variance
- Annualized dividend yield
- Cost of Capital
- Value of Call (lower bound)
- Value of Call (Maximum Flexibility)
- Value of financial flexibility (in annual terms)

1. All the assumptions underlying the Black-Scholes model apply
2. The dividend yield over the lifetime of the option is known and a constant.

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