afm 204 - class 8 slides - cost of debt (1).pptx
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8/9/2019 AFM 204 - Class 8 Slides - Cost of Debt (1).pptx
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Class 8 Slides
Cost of Debt
WACC
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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
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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
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+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
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+/-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
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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
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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%
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;-*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
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;- +/-
• 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 +/-
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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
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;- +/-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)
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;- 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
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;- 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
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;- 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
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;- -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
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;- 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%
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;- 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
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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
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/he 23,+ear /,&ond +ield
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23,+ear Corporate Spreads
32
@
6
1N
8
Governent Corporate
% Yield
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Spreads b% Credit Rating
3
1
23
21
@3
@163
61
3
AAA AA A &&& && & CCC
% Yield
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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
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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
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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
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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
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/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
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WACC Choices are -aterial
•
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;- 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
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;- 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
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;- 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
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