Transcript
8/8/2019 capstru
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Objective
Before you start
Inputs
Units
Income inputs
Balance Sheet
Market Data
Tax Rate
Default Spreads
Summary
Details
References
Corporate Finance
Applied Corporate
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Question
Q1: What do I do excel says there are circular referen
Q2: My spreadsheet has gone crazy. I get errors all ov
What did I do wrong?
Q3: I am entering the inputs for my company but the
optimal numbers do not seem to change from theoriginals
Q4: I am getting an optimal debt ratio of 0%. This ca
be right. Can it?
Q5: My cost of capital at my optimal debt ratio is hig
than the current cost of capital. I thought it was suppo
to be lower.
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Answer
Go into preferences, choose calculation options and make sure the iteration box has a check in it.
I am sorry to say this, but you probably just made an input error. While you might have
fixed it, the iterations in the spreadsheet make it very sensitive and the errors will not
go away. The only fix (Sorry, sorry…) is to copy the inputs into a fresh version of the spreadsheet.
You probably forgot to check the iteration box (see Q1)
Sure. If your operating income is either negative or very low, relative to your firm value,
you can end up at an optimal debt ratio of 0%. For instance, if you have EBIT of 100 on a
firm value of 10000, a 10% debt ratio would probably push you into a C rating and give
you a very high cost of capital.
Generally, you are right. However, I would suggest that you look at three factors:
- If your optimal is just slightly higher or lower than your current debt ratio, it is possible that you
are closer to the optimal than the stated optimal. Let me explain. Assume that you are at a 24% debt ratio
and the optimal comes out to 30%. The true optimal is really somewhere around 30% since
I am constrained to work in 10% increments of the debt ratio. If the true optimal were
26%, your current debt ratio of 24% is closer to the optimal.
- Rating Differences: One of the costs of rating a company based only on the interestcoverage ratio is that the rating might be very different from the actual rating. Thus, your
current cost of capital is based upon your current rating, and the optimal is based upon
the synthetic ratings, and the two don't match, the current and the optimal cost of capital
can be mismatched. You can get around this by switching to a synthetic rating for computing
the current cost of capital (in the input sheet).
- Existing debt at low rates: I assume in the spreadsheet that existing debt gets refinanced at
the new pre-tax cost of debt at each debt ratio. Consequently, if you have a lot of old debt on
your books at much lower rates, the interest expense that I report will be much higher than
your actual interest expense. This, in turn, can affect your interest coverage ratio and rating.
This, too, you can fix by locking in debt at current rates in the input sheet.
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Inputs
Please enter the name of the company you are analyzing: Walt Disney
Financial Information
Earnings before interest, taxes and depreciation (EBITDA) $3,790.00
Depreciation and Amortization: $1,077.00
Capital Spending: $1,049.00
Interest expense on debt: $666.00
Tax rate on ordinary income: 37.30%
Current Rating on debt (if available): BBB+
Interest rate based upon rating: 5.25%
Market Information
Number of shares outstanding: 2475.09
Market price per share: $22.26
Beta of the stock: 1.25
Book value of debt: $13,100.00
Can you estimate the market value of the outstanding debt? No
If so, enter the market value of debt:
Do you want me to try and estimate market value of debt? Yes
If yes, enter the average maturity of outstanding debt? 11.53
Do you have any operating leases? Yes
General Market Data
Current long-term (LT) government bond rate: 4.00%
Risk premium (for use in the CAPM) 4.82%
General Data
Which spread/ratio table would you like to use for your anlaysis? 1
Do you want to assume that existing debt is refinanced at the 'new' rate? Yes
Do you want the firm's current rating to be adjusted to the synthetic rating? Yes
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(in percent)
(in percent)
(Yes or No)
(Yes or No)
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Operating Lease CoOperating lease expenses are really financial expenses, and should be treated as such. Acc
be treated as operating expenses. This program will convert commitments to make operati
adjust the operating income accordingly, by adding back the imputed interest expense on t
Inputs
Operating lease expense in current year = $556.00
Operating Lease Commitments (From footnote to financials)
Year Commitment ! Year 1 is next year, ….
1 $271.00
2 $242.00
3 $221.00
4 $208.00
5 $275.00
6 and beyond $1,033.00
Pre-tax Cost of Debt = Err:522 ! If you do not have a cost of debt, use the attached rat
From the current financial statements, enter the following
Reported Operating Income (EBIT) = $2,713.00 ! This is the EBIT reported in the cu
Reported Interest Expenses = $666.00
Output
Number of years embedded in yr 6 estimate = 4 ! I use the average lease expense ov
to estimate the number of years of e
Converting Operating Leases into debt
Year Commitment Present Value
1 $271.00 Err:522
2 $242.00 Err:522
3 $221.00 Err:5224 $208.00 Err:522
5 $275.00 Err:522
6 and beyond $258.25 Err:522 ! Commitment beyond year 6 converted into an annuit
Debt Value of leases = Err:522
Restated Financials
Operating Income with Operating leases reclassified as debt = Err:522
Interest expenses with Operating leases classified as debt = Err:522
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nverterunting standards allow them to
g leases into debt and
his debt.
ings estimator
rrent income statement
r the first five years
xpenses in yr 6
y for ten years
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Inputs for synthetic rating estimationEnter the type of firm = 1 (Enter 1 if large manufacturing firm, 2 if smaller or ris
Enter current Earnings before interest and taxes (EBIT) = Err:522
Enter current interest expenses = Err:522
Enter current long term government bond rate = 4.00%
OutputInterest coverage ratio = Err:522
Estimated Bond Rating = Err:522
Estimated Default Spread = Err:522
Estimated Cost of Debt = Err:522
For large or stable firms
If interest coverage ratio is
> to≤ Rating is Spread is
-100000 0.2 D 20.00%
0.2 0.65 C 12.00%
0.65 0.8 CC 10.00%
0.8 1.25 CCC 8.00%1.25 1.5 B- 6.00%
1.5 1.75 B 4.00%
1.75 2 B+ 3.25%
2 2.25 BB 2.50%
2.25 2.5 BB+ 2.00%
2.5 3 BBB 1.50%
3 4.25 A- 1.00%
4.25 5.5 A 0.85%
5.5 6.5 A+ 0.70%
6.5 8.5 AA 0.50%
8.50 100000 AAA 0.35%
For smaller and riskier firms
If interest coverage ratio is
greater than to≤ Rating is Spread is
-100000 0.5 D 20.00%
0.5 0.8 C 12.00%
0.8 1.25 CC 10.00%
1.25 1.5 CCC 8.00%
1.5 2 B- 6.00%
2 2.5 B 4.00%
2.5 3 B+ 3.25%
3 3.5 BB 2.50%3.5 4 BB+ 2.00%
4 4.5 BBB 1.50%
4.5 6 A- 1.00%
6 7.5 A 0.85%
7.5 9.5 A+ 0.70%
9.5 12.5 AA 0.50%
12.5 100000 AAA 0.35%
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kier firm, 3 if financial service firm)
(Add back only long term interest expense for financial firms)
(Use only long term interest expense for financial firms)
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CAPITAL STRUCTURE
Walt DisneyCapital Structure Financial Market Income Statement
Current MV of Equity = $55,101 Current Beta for Stock = 1.25 Current EBITDA = Err:522
Market Value of interest-bearing d $12,915 Current Bond Rating = BBB+ Current Depreciation = $1,077
# of Shares Outstanding = 2475.09 Summary of Inputs Current Tax Rate = 37.30%
Debt Value of Operating leases (if Err:522 Long Term Government Bond 4.00% Current Capital Spending= $1,049
Risk Premium = 4.82% Pre-tax cost of debt = 5.25% Current Interest Expense = Err:522
RESULTS FROM ANALYSIS
Current Optimal Change
D/(D+E) Ratio = Err:522 Err:522 Err:522
Implied Growth Rate Calculation
Beta for the Stock = 1.25 Err:522 Err:522 Value of Firm Err:522
Cost of Equity = 10.00% Err:522 Err:522 Current WACC Err:522
Current FCFF Err:522 ! I a
AT Interest Rate on Debt = Err:522 Err:522 Err:522 Implied Growt Err:522
If this number is >Riskfree rate, I u
WACC Err:522 Err:522 Err:522
Implied Growth Rate = Err:522
Assumes constant saving Firm Value (no growth) = Err:522 Err:522 Err:522
Assumes perpeutal growth Firm Value (Perpetual Growth Err:522 Err:522 Err:522
Value/share (No Growth) = Err:522 Err:522 Err:522
Value/share (Perpetual Growth Err:522 Err:522 Err:522
We use the following default spreads in our analysis. Change them in the input sheet if necessary: Ratings comparison at current debt ratio
Rating Coverage gt and lt Spread Current Interest coverage ratio = E
AAA 8.5 100000 0.35% Rating based upon coverage = E
AA 6.5 8.5 0.50% Interest rate based upon coverage = E
A+ 5.5 6.5 0.70% Current rating for company =
A 4.25 5.5 0.85% Current interest rate on debt =
A- 3 4.25 1.00%
BBB 2.5 3 1.50%
BB 2 2.25 2.50%
B+ 1.75 2 3.25%
B 1.5 1.75 4.00%
B- 1.25 1.5 6.00%
CCC 0.8 1.25 8.00%
CC 0.65 0.8 10.00%
C 0.2 0.65 12.00%
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CAPITAL STRUCTURE
D -100000 0.2 20.00%
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CAPITAL STRUCTURE
Current beta= 1.25 Current Equity= $55,101 Current Depreciation= $1,077
Current Debt= Err:522 Current EBITDA= Err:522 Current Interest rate (Company)= 5.25%
Tax rate= 37.30% Current Rating= BBB+ Current T.Bond rate= 4.00%
WORKSHEET FOR ESTIMATING RATINGS/INTEREST RATES
D/(D+E) 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00%
D/E 0.00% 11.11% 25.00% 42.86% 66.67% 100.00% 150.00% 233.33% 400.00% 9
$ Debt $0 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Beta Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522Cost of Equity Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
EBITDA Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Depreciation $1,077 $1,077 $1,077 $1,077 $1,077 $1,077 $1,077 $1,077 $1,077
EBIT Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Interest $0 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Taxable Income Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Tax Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Net Income Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
(+)Deprec'n $1,077 $1,077 $1,077 $1,077 $1,077 $1,077 $1,077 $1,077 $1,077
Funds from Op. Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Pre-tax Int. cov ∞ Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Funds/Debt ∞ Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Likely Rating AAA Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Pre-tax cost of debt 4.35% Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Eff. Tax Rate 37.30% Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
COST OF CAPITAL CALCULATIONS
D/(D+E) 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00%
D/E 0.00% 11.11% 25.00% 42.86% 66.67% 100.00% 150.00% 233.33% 400.00% 9
$ Debt $0 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Cost of equity Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Cost of debt 2.73% Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Cost of Capital Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Value (no growth) Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
Value (perpetual gr Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522 Err:522
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CAPITAL STRUCTURE
Interest cov Interest cov RATING Interest rate
Low High
-100000 0.2 D 24.00%
0.2 0.65 C 16.00%
0.65 0.8 CC 14.00%
0.8 1.25 CCC 12.00%
1.25 1.5 B- 10.00%
1.5 1.75 B 8.00%
1.75 2 B+ 7.25%
2 2.25 BB 6.50%
2.25 2.5 BB+ 6.00%
2.5 3 BBB 5.50%
3 4.25 A- 5.00%
4.25 5.5 A 4.85%
5.5 6.5 A+ 4.70%
6.5 8.5 AA 4.50%
8.5 100000 AAA 4.35%
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CAPITAL STRUCTURE
working capital
ree rate as a perpetual growth rate.
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CAPITAL STRUCTURE 22
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CAPITAL STRUCTURE 23
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CAPITAL STRUCTURE 24
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Chart - Cost of Equity
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0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
0.00
2.00
4.00
6.00
8.00
10.00
12.00
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Cost of Equity and Beta: Debt Ratios
Beta
Cost of Equity
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Debt Ratio Beta Cost of Equity Bond Rating Interest rate on debt Tax Rate
0% Err:522 Err:522 AAA 4.35% 37.30%
10% Err:522 Err:522 Err:522 Err:522 Err:522
20% Err:522 Err:522 Err:522 Err:522 Err:522
30% Err:522 Err:522 Err:522 Err:522 Err:522
40% Err:522 Err:522 Err:522 Err:522 Err:522
50% Err:522 Err:522 Err:522 Err:522 Err:52260% Err:522 Err:522 Err:522 Err:522 Err:522
70% Err:522 Err:522 Err:522 Err:522 Err:522
80% Err:522 Err:522 Err:522 Err:522 Err:522
90% Err:522 Err:522 Err:522 Err:522 Err:522
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ost of Debt (after-tax) WACC Firm Value (G)
2.73% Err:522 Err:522
Err:522 Err:522 Err:522
Err:522 Err:522 Err:522
Err:522 Err:522 Err:522
Err:522 Err:522 Err:522
Err:522 Err:522 Err:522Err:522 Err:522 Err:522
Err:522 Err:522 Err:522
Err:522 Err:522 Err:522
Err:522 Err:522 Err:522