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    Cost of Debt

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    Olivier M
    The document discusses methods for calculating the cost of debt, both for non-tradable and redeemable debt, and uses examples to demonstrate how to calculate net present value and internal rate of return for debt instruments. It also examines how the weighted average cost of capital is affected by changes in the capital structure of a company, specifically as the proportion of debt increases and the costs of debt and equity rise.

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    Cost of Debt

    Uploaded by

    Olivier M
    14 views10 pages
    The document discusses methods for calculating the cost of debt, both for non-tradable and redeemable debt, and uses examples to demonstrate how to calculate net present value and internal rate of return for debt instruments. It also examines how the weighted average cost of capital is affected by changes in the capital structure of a company, specifically as the proportion of debt increases and the costs of debt and equity rise.

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    The document discusses methods for calculating the cost of debt, both for non-tradable and redeemable debt, and uses examples to demonstrate how to calculate net present value and internal rate of return for debt instruments. It also examines how the weighted average cost of capital is affected by changes in the capital structure of a company, specifically as the proportion of debt increases and the costs of debt and equity rise.

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    14 views10 pages

    Cost of Debt

    Uploaded by

    Olivier M
    The document discusses methods for calculating the cost of debt, both for non-tradable and redeemable debt, and uses examples to demonstrate how to calculate net present value and internal rate of return for debt instruments. It also examines how the weighted average cost of capital is affected by changes in the capital structure of a company, specifically as the proportion of debt increases and the costs of debt and equity rise.

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
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    Cost of Debt (non Trad

    Kd Interest (Coupon Rate) x (1-T)

    Cost of Debt- Irredem

    -Generally, the par value of such debt is $ 100


    -Interest paid is a % of nominal value ($100) which
    - If the interest is due but not paid, the prices are c

    Kd (net) i (1-T) x 100%


    P0

    Kd (net) i(1-t)/P0 x 100%

    i 10

    5.83%

    Cost of Debt- Redeem

    -Generally, the par value of such debt is $ 100


    -Interest paid is a % of nominal value ($100) which
    - If the interest is due but not paid, the prices are c
    - At redemption date,they can be redeemed at par
    "-The Kd (net) is given by the IRR of cashfows

    7%
    Example

    Year 0 1-5
    CF -102 7
    DF 1 4.1
    PV -102 28.7
    NPV -2

    5%
    Example

    Year 0 1-5
    CF -102 7
    DF 1 4.329
    PV -102 30.303
    NPV 6.703

    IRR

    A/(A-B) 0.77019419
    b%-a% 2.00%
    IRR 6.54%

    IRR= A% + A/(A-B)*(b%-a%)

    Example 2
    7%
    Year CF DF
    0 -102 1
    1-5 7 4.1
    5 104 0.713

    NPV 0.852

    9%
    Year CF DF
    0 -102 1
    1-5 7 3.89
    5 104 0.65

    NPV -7.17

    A/(A-B) 0.10620793
    b%-a% 2.00%
    IRR 7.21%
    Source Market ValuProportion Cost
    $m
    Equity 60 90% 15%
    Debt 6.8 10% 7.60%
    Total 66.8

    WACC Ke(Ve/(Ve+Vd) +Kd (Vd/(Ve+Vd)

    MV CF
    WACC

    As devt increases, the debt burden gets more and more bigge
    As you pay more and more interest, you are eating into the ca
    Because of the higher levels of interest, the dividends that th
    We may end up in a situation where all the profits are being p
    The increased level of risk that the shareholders experience, r
    As the Ke increases and the cost of debt continues to increase
    Increase MV !!!

    Be proxy 1.3 Ve
    Ba 0.89

    For Investment conditions :

    Ve

    Be 1.15

    Ke = Rf + (Rm-Rf) * B

    Ke 16%

    WACC

    Source Proportion Cost WACC

    Debt 30% 3% 1%
    Equity 70% 16% 11%

    WACC 12%
    Cost of Debt (non Tradable)

    upon Rate) x (1-T)

    Cost of Debt- Irredemable

    of such debt is $ 100


    ominal value ($100) which is known as the coupon rate
    t not paid, the prices are cum interest price, else they are EX interest price

    Cost of Debt- Redeemable

    of such debt is $ 100


    ominal value ($100) which is known as the coupon rate
    t not paid, the prices are cum interest price, else they are EX interest price
    y can be redeemed at par, discount or premium
    the IRR of cashfows

    5
    100
    0.713
    71.3

    5
    100
    0.784
    78.4

    PV
    -102 Redemption Value of Cash 100
    28.7 Redemption Value of Shares 104
    74.152

    PV
    -102
    27.23
    67.6
    WACC 8000000
    100
    13.473053892215600% 80000
    0.773652694610778% 6,800,000
    14%

    Vd) +Kd (Vd/(Ve+Vd)

    gets more and more bigger, you have to pay more and more interest.
    , you are eating into the cashflows available to pay dividends to the shareholders
    rest, the dividends that the shareholders are due to receive become more and more risky
    e all the profits are being paid out as interest and there is nothing left to pay dividends to shareholders
    shareholders experience, result in an increase in the cost of equity
    debt continues to increase, there is an increase in the WACC
    Decrease MV !!!

    60% Vd 40%
    70% Vd 30%

    Rf 4%
    Rm 14%

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