Cost of Debt .

• Cost of Debt

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Mergers and acquisitions - Financing options

1 It consumes financial slack, may decrease debt rating and increase

cost of debt. Transaction costs include underwriting or closing costs

of 1% to 3% of the face value.



1 Issue of stock: it increases financial slack, may improve debt rating and

reduce cost of debt. Transaction costs include fees for preparation of a proxy statement, an extraordinary

shareholder meeting and registration.



1 Shares in treasury: it increases financial slack (if they don’t have to be repurchased on the market), may improve debt rating and reduce cost

of debt. Transaction costs include brokerage fees if shares are

repurchased in the market otherwise there are no major costs.


Economics of new nuclear power plants - Capital costs

1 Some analysts argue (for example Steve Thomas, Professor of Energy Studies at the University of

Greenwich in the UK, quoted in the book The Doomsday Machine (2012 book)|The Doomsday Machine by Martin

Cohen and Andrew McKillop ]) that what is often not appreciated in debates about the economics of nuclear power is that the cost of equity, that is companies using

their own money to pay for new plants, is generally higher than the cost of debt.The Doomsday Machine,

Cohen and McKillop (Palgrave 2012) page 199 Another advantage of borrowing may be that once large loans

have been arranged at low interest rates - perhaps with government support - the money can then be lent out at

higher rates of return.


Merger - Financing options

1 *It consumes financial slack, may decrease debt rating and increase

cost of debt. Transaction costs include underwriting or closing costs

of 1% to 3% of the face value.



1 *Issue of stock: it increases financial slack, may improve debt rating and

reduce cost of debt. Transaction costs include fees for preparation of a proxy statement, an extraordinary

shareholder meeting and registration.



1 *Shares in treasury: it increases financial slack (if they don’t have to be repurchased on the market), may improve debt rating and reduce cost

of debt. Transaction costs include brokerage fees if shares are

repurchased in the market otherwise there are no major costs.


Corporate finance - Capitalization structure

1 The cost of equity (see Capital asset pricing model|CAPM and arbitrage pricing theory|APT) is also typically higher than the cost of debt - which is,

additionally, a deductible expense – and so equity financing may result in an increased hurdle rate

which may offset any reduction in cash flow risk.See:[

http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-

Management-Market-Volatility-Proposed-Changes-3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed

Changes], Nishant Choudhary, LL.M


Leverage (finance) - Worked example

1 Interest rate differential = Return on investment less Cost of debt = 5% - 4% = 1%


Business valuation - Weighted average cost of capital (WACC)

1 The weighted average cost of capital is an approach to determining a discount rate. The

weighted average cost of capital|WACC method determines the subject company’s

actual cost of capital by calculating the weighted average of the company’s interest

(finance)|cost of debt and cost of stock|equity. The weighted average cost of capital|

WACC must be applied to the subject company’s net cash flow to total invested

capital.


Modigliani-Miller theorem - Proposition II

1 * r_D is the required rate of return on borrowings, or cost of

debt.


Working capital management - Capitalization structure



which may offset any reduction in cash flow risk.See:[http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-Management-Market-Volatility-Proposed-Changes-

3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed



Time value of money - Calculations

1 The rate of return in the calculations can be either the variable solved for, or a predefined variable that measures a

discount rate, interest, inflation, rate of return, cost of equity, cost of debt or any

number of other analogous concepts. The choice of the appropriate rate is

critical to the exercise, and the use of an incorrect discount rate will make the

results meaningless.


History of private equity and venture capital - SL and the shutdown of the Junk Bond Market

1 This made the cost of debt in the high yield market significantly more

expensive than it had been previously.Altman, Edward I


Convertible bond - Valuation

1 A simple method for calculating the value of a convertible involves calculating the present value of

future interest and :wikt:principal|principal payments at the cost of

debt and adds the present value of the warrant (finance)|warrant


Working capital management - Capitalization structure



which may offset any reduction in cash flow risk.See:[http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-Management-Market-Volatility-Proposed-Changes-

3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed



Undercapitalization - Capital sources

1 * Debt is more expensive. The cost of debt is lowest with secured, long-

term loans or use of personal savings, higher with unsecured loans, credit card loans and cash advances, and with factoring (finance)|factoring

accounts receivable.


Tax shield - Case B

1 The reason that he was able to earn additional income is because the cost

of debt (i.e. 8%) is less than the return earned on the investment (i.e.

10%). The 2% difference makes income of $80 and another $100 is

made by the return on equity capital. Total income becomes $180 which

becomes taxable at 20%.


Adjusted present value

1 Technically, an APV valuation model looks similar to a standard

Discounted cash flow|DCF model. However, instead of weighted

average cost of capital|WACC, cash flows would be discounted at the unlevered cost of equity, and tax shields at either the cost of debt

(Myers) or following later academics also with the unlevered cost of

equity.http://www.iese.edu/research/pdfs/DI-0488-E.pdf


Adjusted present value - APV formula

1 The discount rate used in the second part is the cost of debt financing by period.


Adjusted present value - APV formula

1 + Present Value of Debt's Periodic Interest Tax Shield discounted by Cost of Debt Financing

%


Cost of capital - Summary

1 A company's securities typically include both debt and equity, one must therefore calculate both the

cost of debt and the cost of equity to determine a company's cost of

capital



1 For companies with similar risk or Bond credit rating|credit ratings, the

interest rate is largely exogenous (not linked to the cost of debt), the cost of equity is broadly defined as the risk-weighted projected return required by investors, where the

return is largely unknown



1 Once cost of debt and cost of equity have been determined, their blend, the weighted-average cost of capital

(WACC), can be calculated. This WACC can then be used as a Annual effective discount rate|discount rate for a project's projected cash flows.


Cost of capital - Cost of debt

1 Since in most cases debt expense is a deductible expense, the cost of

debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are After Taxes|

after-tax as well)


Cost of capital - Cost of debt

1 The yield to maturity can be used as an

approximation of the cost of debt.


Merger and acquisitions - Financing options

1 *Issue of debt: It consumes financial slack, may decrease debt rating and

increase cost of debt. Transaction costs include underwriting or closing costs of 1% to 3% of the face value.


Return on equity - The DuPont formula

1 So if the firm takes on too much debt, the cost of debt rises as creditors demand a higher risk

premium, and ROE decreases.Woolridge, J


Bankruptcy costs

1 In the Trade-Off Theory of capital structure, firms are supposedly

choosing their level of debt financing by trading off these bankruptcy costs of debt against tax benefits of debt. In particular, a firm that is trying to

maximize the value for its shareholders will equalize the

marginal cost of debt that results from these bankruptcy costs with the marginal benefit of debt that results

from tax benefits.


Countrywide Financial Corporation - Secondary market disruption

1 There can be no assurance, however, that the Company will be successful in these efforts, that such facilities will be adequate or that the cost of

debt will allow us to operate at profitable levels.


Hamada's equation

1 # The discount rate used to calculate the tax shield is assumed to be equal to the cost of debt capital (thus, the

tax shield has the same risk as debt). This and the constant debt

assumption in (1) imply that the tax shield is proportionate to the market

value of debt: Tax Shield = T×D.


Public-private partnerships - Controversy

1 Making a simple comparison, however, between the government’s cost of debt and the private-sector WACC implies that the government can sustainably fund projects at a

cost of finance equal to its risk-free borrowing rate


Pecking Order Theory - Theory

1 This does not however apply to high-tech industries where the issue of

equity is preferable due to the high cost of debt issue as assets are

intangible Brealey RA, Myers SC, and Allen F (2008)


Cost of debt - Cost of debt

1 Since in most cases debt expense is a deductible expense, the cost of

debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are after-tax as

well)


Weir Group - History

1 Worthington-Simpson was

profitable, but did not cover the cost of

debt.https://store.theartofservice.com/the-cost-of-debt-toolkit.html

Affordability of housing in Canada - Market-based affordability

1 Mortgage lending institutions define affordability in terms of potential

home buyers consider the relative cost of debt based on interest rates

and average household incomes


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Cost of Debt .

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