Carrying out a cost/benefit analysis of under-indebtedness is not a matter of optimising an accounting ratio at a given time, but of evaluating a real strategic option. Under-indebtedness is considered a “reserve of power” (flexibility) that comes at an immediate price but offers potential future gains.

Here is the methodology for structuring this analysis:

1. Calculate the “Cost” of Under-Indebtedness (The Option Premium)

The cost of under-indebtedness is an opportunity cost. It corresponds to the additional financing cost that the company agrees to pay by not maximizing its leverage effect.

• The principle: Debt is generally cheaper than equity (lower risk premium for creditors and tax deductibility of interest). In theory, an optimal financial structure (minimizing the WACC) includes a significant portion of debt.
• Calculating the cost: It is necessary to compare the current Weighted Average Cost of Capital (WACC) with the theoretical minimum WACC that the company could achieve by taking on more debt (generally up to a debt ratio close to 1).

Capital Invested × (Real WACC (Under-Leveraged) – Minimum WACC (Optimized))

• Interpretation: This differential represents the “insurance premium” or “option premium” that the company pays to maintain its freedom of movement.

2. Estimate the “Benefit” (The Value of Flexibility)

The benefit of under-indebtedness is financial flexibility. It is the company’s ability to seize unanticipated investment opportunities (acquisitions, price wars, R&D) that its over-indebted competitors will not be able to finance.

• Nature of Gain: It is a growth option (GORO). It makes it possible to capture future opportunities (upside) while avoiding the risk of bankruptcy in the event of a crisis (downside).
• The (Theoretical) calculation:
  • Value = Probability of a major investment opportunity times Value created by that investment (NPV).
  • Note: This profit is difficult to quantify ex-ante. It is often only measurable when the opportunity arises (e.g. takeover of a competitor).
• Competitive advantage (Game Theory): If all the players in a sector maximize their debt to reduce their WACC, the one that remains under-indebted has a major strategic advantage. It will be the only one capable of buying a target or resisting a price war, where the others will be paralyzed by their repayment deadlines.

3. Confronting Cost and Benefit according to the Context (Arbitration)

The analysis does not give the same result depending on the company’s environment:

• Stable Environment (Profit < Cost): If the market is mature, predictable and without external growth opportunities, paying a premium for flexibility is a waste. Under-indebtedness destroys value because the cost of capital is unnecessarily high without a strategic counterpart.
• Volatile/Consolidating Environment (Profit > Cost): If the sector is uncertain or in the midst of consolidation (many potential targets), the cost of under-indebtedness is justified.
  • Example Danone (BSN): Thanks to low leverage (0.3), BSN was able to buy the European subsidiaries of RJR Nabisco in one week for $2.5 billion, doubling the stake of competitors unable to match so quickly.
  • Lafarge counter-example: Too indebted to maximize its return on equity, Lafarge was unable to respond effectively to a price war initiated by a competitor (Orascom) and ended up losing its independence.

In summary

The cost/benefit analysis of under-indebtedness amounts to answering the following question: “Is the additional cost of capital that I pay today (by not taking on debt) lower than the expected value of the strategic opportunities that this cash reserve will allow me to seize tomorrow?”.