Most of the vast literature on the role of debt in corporate valuation proceeds from the vantage point of corporate finance (i.e., ascertaining the effects of adding debt to a previously unlevered company).
Most of the vast literature on the role of debt in corporate valuation proceeds from the vantage point of corporate finance (i.e., ascertaining the effects of adding debt to a previously unlevered company). The investment analyst, however, confronts an already-levered company with already-levered return parameters. The analyst's challenge is to estimate the stock's theoretical value by inferring the company's underlying structure of returns. This shift in vantage point leads to results about the effect of leverage on P/E valuations that are surprisingly different from the results of studies from the corporate finance angle. This Research Foundation research paper places the leveraged-P/E work in the context of the franchise value approach and is intended to explain the general development of P/E sensitivity to leverage. In that sense, it is a companion piece to "The Levered P/E Ratio," published in the November/December 2002 Financial Analysts Journal.