Debt Sizing in Excel

DEBT SIZING IN EXCEL

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FIONA COLLINSON Head of Banking and Advisory, F1F9 BSc (Hons), ACIB, Cert Corp Finance, CISI Standard Chartered - Commercial Banking, Deutsche Bank and Goldman Sachs - Investment Banking

KENNY WHITELAW-JONES Managing Director, F1F9 MA (Hons), MBA, AMCT @Kenny_WJ

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FIONA COLLINSON

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SCENARIO European listed business Investment requirements: • Capital expenditure for modernisation of manufacturing and addition of product lines • Increase in permanent working capital • Refinancing of short term debt

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DEBT SIZING METHODS: 2

Based on discounting of forecast cash flows available cash to service and repay interest bearing debt in a timeframe acceptable to senior lenders

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Based on optimal capital structure theory

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Based on credit rating

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APPROACH 1: DISCOUNTING CFADS CASH FLOW AVAILABLE FOR DEBT SERVICE (ALSO KNOWN AS FREE CASH FLOW): EBIT or operating profit x (1-t) + Depreciation + Amortization + / - other non-cash events - All capital expenditures + / - changes in net working capital

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APPROACH 1: DISCOUNTING CFADS CFADS BASED DEBT CAPACITY CALCULATION:

n = final number of years r = after tax cost of long term debt (cd) The coverage ratio applied to CFADS depends on the volatility and deliverability of the cash flows

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DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS PERSPECTIVE

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USED CORRECTLY, DISCOUNTING OF SUSTAINABLE CFADS CAN BE USED AS A STRUCTURING TOOL TO ESTABLISH MAXIMUM ACCEPTABLE SENIOR DEBT CAPACITY

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APPROACH 2: DISCOUNTING OF SUSTAINABLE CFADS CREDIT ANALYST RESTATES CASH FLOW TO A NOTIONAL CASHFLOW ON WHICH THE LENDING BANKER CAN RELY. SUSTAINABLE CASH FLOW NEEDS TO BE CALCULATED:

After maintenance capital expenditure Before interest After tax

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APPROACH 2: DISCOUNTING OF SUSTAINABLE CFADS SUSTAINABLE CASH FLOW DEFINITION:

plus less

EBIT * (1 – tax rate) DEPRECIATION AND AMORTISATION MAINTENANCE CAPITAL EXPENDITURE

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APPROACH 3: WACC WEIGHTED AVERAGE COST OF CAPITAL (WACC) IS THE AVERAGE COST TO A COMPANY OF THE CAPITAL INVESTED TO FUND THE ASSETS OF THE COMPANY. DEBT AND EQUITY COMPONENTS OF THE COST OF CAPITAL ARE DETERMINED AT MARKET RATES.

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OPTIMAL CAPITAL STRUCTURE MORE DEBT = INCREASED VALUE OF TAX SHIELD MORE DEBT = HIGHER RETURN REQUIRED BY BOTH DEBT AND EQUITY HOLDERS

DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS PERSPECTIVE

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APPROACH 3: WACC CALCULATING WACC:

WACC = [ cd * (1 – t ) * wd ] + [ce * we] cd = cost of debt t = tax rate wd = weight of debt ce = cost of equity we = weight of equity

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WACC CALCULATION Cost of debt cd x (1 – t)

Cost of equity rf + (MRP * β)

Market value of debt PV(rate, nper, pmt, fv)

Market value of equity Share price x shares

DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT WACC PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS MV equity MV debt ce x cd x (1 – t) x PERSPECTIVE MV debt + equity + MV debt + equity

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OPTIMAL CAPITAL STRUCTURE THE POINT AT WHICH WACC IS AT THE MIMIMUM.

DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS PERSPECTIVE THIS IS ALSO THE POINT WHERE THE VALUE OF THE FIRM IS MAXIMISED

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APPROACH 4: CREDIT RATING WWW.F1F9.COM

OPTIMAL CAPITAL STRUCTURE THE POINT AT WHICH WACC IS AT THE MIMIMUM.

DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS PERSPECTIVE THIS IS ALSO THE POINT WHERE THE VALUE OF THE FIRM IS MAXIMISED

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APPROACH 4: CREDIT RATING A STRATEGY OF MAINTAINING A CERTAIN CREDIT RATING CAN LEAD TO A DEVIATION FROM THE OPTIMAL CAPITAL STRUCTURE WHICH MAY HAVE A VALUATION IMPACT.