afm 204 - class 8 slides - cost of debt (1).pptx

8/9/2019 AFM 204 - Class 8 Slides - Cost of Debt (1).pptx

1/31

Class 8 Slides

Cost of Debt

WACC


2/31

Recap

• We are looking for the Weighted AverageCost of Capital (WACC)

Where:

D = $ ao!nt of debt o!tstanding (arket capitali"ation)

# = $ ao!nt of e!it% o!tstanding (arket capitali"ation)

WACC =D

D+E *K d *(1−T )+

E

D+E *K e

K e = Rf + β * (EMRP)K d = Rf + spread


3/31

Cost of Debt

• Cost of Debt can theoreticall% !se thesae ethodolog% as the Cost of #!it% – &onds are ver% !ni!e' hat benchark

sho!ld be !sed

– Where do %o! find the data for a &etacalc!lation hen the bonds do not trade

• So' e take the second best choice' hichis to !se other estiates of the fir*s costof debt


4/31

+ield,to,-at!rit%

• .deall%' e o!ld !se the +ield,to,-at!rit% (+/-) for a bond nel% iss!edb% the copan% –

0as the copan% had an% recent bondiss!es• .f so' ho far in the past

– What is the at!rit% of the bond –

0o does the bond fit into the copan%*sf!t!re capital str!ct!re plans• Does the copan% roll over 1,%ear bonds 23,

%ears bonds 2,%ear bonds


5/31

+/-s

• Alternativel%' look for fi4ed rate long,terbond %ields of previo!sl% iss!ed debt – We ant c!rrent %ield' not the co!pon rate –

5ricing and %ield data a% be to!gh to find• When as the last tie the bond traded• .s the last trade far eno!gh in the past that the

%ield,to,at!rit% at the last traded price is nolonger applicable

• C!rrent %ields on inactivel% traded bondsa% not be !p,to,date eno!gh


6/31

Credit Spreads

• A credit spread over Rf can be !sed' after

deciding: – /he d!ration of the debt (1,%ear' 23,%ear' 63,

%ear' etc7)' !se the credit spread over thecorresponding Rf

– /he credit rating of the copan% (AAA' AA'

etc7)• eep in ind that the applicable credit rating is

after the ne debt is borroed


7/31

Co!pon Rates

• Capital .9 provides a s!ar% of thebonds o!tstanding – Ao!nt o!tstanding

– Co!pon rate

• When the bonds ere originall% iss!ed theco!pon rate o!ld have been the bond*s

%ield,to,at!rit% (or at least ver% close) – 5rovides a historical perspective of the fir*s

%ield,to,at!rit%


8/31

;-*s Cost of Debt

• reshl%? iss!ed bonds fro -arch @32 – .ss!ed +/- and c!rrent price

– 6' 1' and 23,%ear bonds

• ;- is rated AAA b% SB5

• So hat sho!ld e !se for ;-*s d


9/31

;- +/-

• Re!ires good pricing data on o!tstandingbonds – 5artic!lar strength of &looberg

– Capital .9 no incl!des bond pricing

• 0o do ;- bonds copare to c!rrent%ields

– &onds trading above par vs7 belo par • .plication for c!rrent +/-


10/31

C!rrent ;- +/-s

• Capital .9' !nder >i4ed .ncoe' presentsa Sec!rities S!ar%? ith soe c!rrentpricing and %ield inforation – Capital .9 reports +ield,to,Worst hich is the

convention for calc!lating +/- that prod!cesthe loest %ield•

&onds ith ebedded options have an% potentialat!rit% dates' +/W !ses the at!rit% date thatprod!ces the loest %ield


11/31

;- +/-s

Maturity Current Price Offering YTM

-arch 21' @32 $233731 37@E-arch 21' @32 $233718 278@E-arch 21' @3@ $236728 6728E

• Which +/- sho!ld e !se – /hese are noinal %ields F hat do the% sa%

abo!t f!t!re econoic o!tp!t• Do the% relate to ;- or GD5

• What is inflation (H@E in @326I)


12/31

;- Credit Spreads

• Corporate bonds trade at a spread abovegovernent bonds – Risk% Corporate &onds vs7 Risk,free

Governent &onds – .n bond trading parlance' credit vs7 cash

– Spreads change over tie' and in ver%' ver%'

rare instances can be negative – When !sing credit spreads ake s!re to

atch the at!rities


13/31

;- Credit Spreads

• ;- is rated AAA b% SB5 – Spreads for AAA corporate bonds var% b% at!rit%

• /here a% be other factors specific to a copan% that ipacts itscredit spread

–C!rrent AAA spread to JS Governent &onds is 3716E (fro&ofA -errill


14/31

;- AAA Credit Spreads

• Jsing the AAA Credit Spread (likel% an!nderestiate for longer,dated at!ritiesgiven the i4ing of at!rities)

• 0o do these d estiates copare to the

c!rrent +/-s

MaturityGovernment

RateAAA Credit

SpreadXOM Kd

90-Day T-Bills 0.03 0.53 0.56

5-year T-Bonds

1.63 0.53 2.16

10-year T-Bonds

2.42 0.53 2.95

30-year T-Bonds

3.33 0.53 3.86


15/31

;- -at!rit% Credit Spreads

• Jsing the credit spreads b% at!rit% (likel%an overestiate of ;-*s cost of debt)

• 0o do these copare to the c!rrent+/-s

Maturity

Government

Rate

Spread By

Maturity XOM Kd5-year T-Bonds 1.63 0.81 2.44

5-year T-Bonds 1.63 1.18 2.81

10-year T-Bonds 2.42 1.31 3.73

10-year T-Bonds 2.42 1.52 3.94

30-year T-Bonds 3.33 1.61 4.94


16/31

;- Co!pon Rates

• .nterest #4pense L /otal Debt – #as% to find' a% be isleading depending on hat is

incl!ded

–

;- has a lot of variable rate bonds ith alost "eroE interest rates• Mariable rates are diffic!lt to odel' think of the variation in

rates since 26

• ;- iss!es a lot of intra,copan% debt' foc!s on the data in

the sec!rities s!ar%


17/31

;- Co!pon Rate

• Jsing the data on the ;- Capital Str!ct!reDetails tab provides a co!pon estiate of 67@E – /his incl!des intra,copan% loans at negligible

interest rates• Jsing the data on the ;- Sec!rities S!ar%

tab provides a co!pon estiate of 6723E – /his is s!bstantiall% ipacted b% the recent (lo

%ield) bond iss!es• Will this contin!e into the f!t!re >or ho long


18/31

0istorical 5erspective

• /he level of governent interest ratesvaries over tie – /he historical data for Rf shos significant

variance over relativel% short periods of tie

• Credit spreads above governent %ieldsalso var% over tie – When %o! are proKecting forard' and

considering corporate d' do c!rrent %ields

and spreads properl% conve% the f!t!re


19/31

/he 23,+ear /,&ond +ield


20/31

23,+ear Corporate Spreads

32

@

6

1N

8

Governent Corporate

% Yield


21/31

Spreads b% Credit Rating

3

1

23

21

@3

@163

61

3

AAA AA A &&& && & CCC

% Yield


22/31

Spreads b% -at!rit%

3

2

@

6

1

N

8

2,6%r 6,1%r 1,%r ,23%r 23,21%r 21%rO

% Yield


23/31

Average Spread b% Rating

Rating Average Spread Current

AAA 378 3716

AA 273 37N

A 27@ 378N

&&& @723 2712

&& 678 @782

& 176 67CCC 22783 7@1


24/31

Average Spread b% -at!rit%

Maturity Average Spread Current

2,6%r 2761 37N3

6,1%r 27 3782

1,%r 272 2728

,23%r 272 2762

23,21%r 273 271@

21%rO 2783 27N2


25/31

Caveats

• Spreads are often presented as largeheterogeneo!s baskets: – /he spreads b% at!rit% incl!de all bonds over &&& in

each at!rit% categor%• What is the average rating

– /he spreads b% rating categor% incl!de bonds acrossall at!rities• What is the average at!rit%

– eep in ind the difference beteen %o!r copan%*scredit rating and d at!rit% vs7 the average rating and

at!rit% !sed to cop!te the credit spreads


26/31

/he >inal 5iece: /a4es

• Which /a4 Rate sho!ld %o! !se• -arginal' Average' #ffective' other

– Cash ta4es paid• Are ta4 rates constant over tie

– 5eriod of losses

– Averages are nice and reasonable' b!tatch for radical !ps and dons overtie

–/o!gh to go rong b% !sing thestat!tor% rate !nless there is as%steatic divergence


27/31

WACC Choices are -aterial

•


28/31

;- WACC F C!rrent Data

Using the Crrent !tate o" #$airs

De%t &"ro' !e(rities!''ary) 9*036

+,ity &aret Ca/italiation) 437*309

d &Crrent T) 2.59

T &!tattory) 35.00

e

" &Crrent 10-year T-Bond) 2.42 Beta &'ost re(ent 1-year) 0.86

+ 5

#CC 6.62


29/31

;- WACC F 0istorical

Using the #erage !tate o" #$airs

De%t &"ro' !e(rities !''ary) 9*036

+,ity &aret Ca/italiation) 437*309

d &istori(al T) 7.35

T &!tattory) 35.00

e

"

erage 10-year T-Bond)6.51

Beta &'ost re(ent 15-years) 0.83

+ 5

#CC 10.56


30/31


31/31

;- WACC Choices

• WACC Difference of onl%? 67E – Difference in WACC leads to 233EO

difference in val!ation

– An% g!esses as to hat the groth rate o!ldhave to be in order for the val!ations to be thesae at their respective WACC• A /erinal Groth rate of ,378E e!ali"es the

c!rrent val!ation to '21

• A /erinal Groth rate of N7E e!ali"es thehistorical val!ation to @36'1

afm 204 - class 8 slides - cost of debt (1).pptx

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