PRELIMINARY STUFF AND INPUTS This spreadsheet allows you to compute the optimal capital structure for a non

-financial service firm. If you have a financial service firm use capstrfin.xls Before you start Open preferences in excel, go into calculation options and put a check in the iteration box. If it is already checked, leave it as is. Inputs The inputs are primarily in the input sheet. If your company has operating leases, use the operating lease worksheet to enter your lease or rental commitments. Units Enter all numbers in the same units (000s, millions or even billions) Income inputs The key income inputs are EBITDA, depreciation and amortization and interest expenses. Enter the most updated numbers you have for each (even if they are 12-month trailing numbers). If the most recent period for which you have data has an operating income that is abnormal, either because of extraordinary losses/gains or some other occurrence, use an average operating income over the last few years. From the statement of cash flows, also enter the capital spending from the recent period. P.S: If you have negative operating income and you expect to continue having negative operating income, your optimal debt ratio will be zero. Balance Sheet Enter the book value of all interest-bearing debt. If you have a market value enter that number. Alternatively, input the average maturity of the debt and I will estimate the market value of debt. Market Data Enter the current stock price, the current long-term government bond rate, the risk premium you would like to use to estimate your cost of equity and the current rating for your firm. If you do not have a rating, there is an option for you at the very bottom of the spreadsheet to compute a synthetic rating. Tax Rate Enter a marginal tax rate, if you can estimate it. Otherwise, use the effective tax rate. Default Spreads This spreadsheet has interest coverage ratios, ratings and default spreads built into it in the worksheet. This spreadsheet treats the imputed interest expense on operating leases as part of the interest expense when computing the interest coverage ratio. You can choose between ratings for large firms (firms with market capitalizations that exceed $ 5 billion is a simple cut off but you can deviate from it) a more conservatve for small or risky firms. If you want, you can change the interest coverage ratios and ratings in these tables. READING THE OUTPUT Summary The summary provides a picture of your firm's current cost of capital and debt ratio, and compares it to your firm's optimal debt ratio and the cost of capital at that level. It then uses the savings from the change in cost of capital to compute how much your firm value will change: - with constant savings: as the present value of a perpetuity - with a growth rate in the savings in perpetuity The firm value change, divided by the number of shares, yields a price change Details The details of the calculation at each debt ratio are below the summary. Objective References Corporate Finance: Theory and Practice, Chapter 18 Applied Corporate Finance: Chapter 8

tings for large firms deviate from it) .

Can it? Q5: My cost of capital at my optimal debt ratio is higher than the current cost of capital. This can't be right. I thought it was supposed to be lower.Question Q1: What do I do excel says there are circular references? Q2: My spreadsheet has gone crazy. What did I do wrong? Q3: I am entering the inputs for my company but the optimal numbers do not seem to change from the originals Q4: I am getting an optimal debt ratio of 0%. I get errors all over. .

If your operating income is either negative or very low. Generally.Rating Differences: One of the costs of rating a company based only on the interest coverage ratio is that the rating might be very different from the actual rating. if you have a lot of old debt on your books at much lower rates. but you probably just made an input error.If your optimal is just slightly higher or lower than your current debt ratio. too. your current debt ratio of 24% is closer to the optimal. you can end up at an optimal debt ratio of 0%. For instance. the iterations in the spreadsheet make it very sensitive and the errors will not go away. the current and the optimal cost of capital can be mismatched.Answer Go into preferences. it is possible that you are closer to the optimal than the stated optimal. choose calculation options and make sure the iteration box has a check in it. You probably forgot to check the iteration box (see Q1) change from the Sure. relative to your firm value. . and the two don't match. The only fix (Sorry. . you are right. in turn. 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.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. This. Consequently. Assume that you are at a 24% debt ratio and the optimal comes out to 30%. Let me explain. You can get around this by switching to a synthetic rating for computing the current cost of capital (in the input sheet). However. The true optimal is really somewhere around 30% since I am constrained to work in 10% increments of the debt ratio. Thus. you can fix by locking in debt at current rates in the input sheet. your current cost of capital is based upon your current rating. I am sorry to say this. This. If the true optimal were 26%. and the optimal is based upon the synthetic ratings. While you might have fixed it. the interest expense that I report will be much higher than your actual interest expense. I would suggest that you look at three factors: . . can affect your interest coverage ratio and rating. sorry…) is to copy the inputs into a fresh version of the spreadsheet.

093 $22.00 37.25 13.077.00 $3.00 $1.00% BBB+ 5.82% (in percent) (in percent) Yes 11.00 $666.00 $1.Inputs Please enter the name of the company you are analyzing: Financial Information Earnings before interest.30% 25.00% 4.049.25% Walt Disney .26 1. taxes and depreciation (EBITDA) Depreciation and Amortization: Capital Spending: Interest expense on debt: Tax rate on ordinary income: Cost of Bankrtupcy as a percent of market value of firm = Current Rating on debt (if available): Interest rate based upon rating: Market Information Number of shares outstanding: Market price per share: Beta of the stock: Book value of debt: Can you estimate the market value of the outstanding debt? If so. enter the average maturity of outstanding debt? Do you have any operating leases? General Market Data Current long-term (LT) government bond rate: Risk premium (for use in the CAPM) General Data Which spread/ratio table would you like to use for your anlaysis? Do you want to assume that existing debt is refinanced at the 'new' rate? Do you want the firm's current rating to be adjusted to the synthetic rating? 2 No Yes (Yes or No) (Yes or No) 4.790.53 Yes $ No 2475. enter the market value of debt: Do you want me to try and estimate market value of debt? If yes.100.

73 767. and should be treated as such.00 $205. 1 $ 271.00% $556. by adding back the imputed interest expense on this debt. This program will convert commitments to make operating leases into debt and adjust the operating income accordingly.50 6 and beyond $ 258.25 $668.73 .54 Restated Financials Operating Income with Operating leases reclassified as debt = Interest expenses with Operating leases classified as debt = $ $ 2.814.00 $215.66 2 $ 242.033. ….00 3 $ 221.00 $185.56 4 $ 208.00 ! If you do not have a cost of debt.00 Output Number of years embedded in yr 6 estimate = 4 ! I use the average lease expense over the first five years to estimate the number of years of expenses in yr 6 Converting Operating Leases into debt Year Commitment Present Value 1 $ 271.Operating Lease Converter Operating lease expenses are really financial expenses.38 3 $ 221.00 2 $ 242.76 5 $ 275.00 Pre-tax Cost of Debt = 6.695. use the attached ratings estimator From the current financial statements. enter the following Reported Operating Income (EBIT) = $2.00 $164. Inputs Operating lease expense in current year = Operating Lease Commitments (From footnote to financials) Year Commitment ! Year 1 is next year.00 $255.00 6 and beyond $ 1.713.69 ! Commitment beyond year 6 converted into an annuity for ten years Debt Value of leases = $ 1.00 ! This is the EBIT reported in the current income statement Reported Interest Expenses = $666. Accounting standards allow th be treated as operating expenses.00 4 $ 208.00 5 $ 275.

ed ratings estimator current income statement over the first five years f expenses in yr 6 nnuity for ten years .nverter pense on this debt.

499999 8.00% 7.499999 4.00% 32.35% 0.41% 0.85% 0.5 6.28% 2.649999 0.50% 12.2499999 2.50 100000 Rating is D C CC CCC BB B+ BB BB+ BBB AA A+ AA AAA Spread is Bankruptcy Probability 20.73 (Use only long term interest expense for fina Enter current long term government bond rate = 4.999999 3 4.799999 0.499999 5.249999 1.9999999 4 4.00% 50.70% 0.814.20% 2.5 8.199999 0.53% 0.50% 0.50% 4.00% 65.70% 0.28% 0.999999 3 3.30% 1.499999 7.00% 65.36% 3.00% Output Interest coverage ratio = 3.499999 6.5 5.999999 6 7.5 2.5 12.5 3.00% 26.75 1.8 1.28% 2.5 1.00% 8.25 1.01% For smaller and riskier firms If interest coverage ratio is greater than ≤ to -100000 0.999999 2 2.00% 32.00% 100% 12.00% 1.73 (Add back only long term interest expense fo Enter current interest expenses = $767.499999 0.49999 2.40% 0.25 1.249999 4.50% 12.499999 1.65 0.00% 6.28% 0.00% 100% 12.00% 26. 3 if financial service firm) Enter current Earnings before interest and taxes (EBIT) = $2.53% 0.36% 3.999999 2 2.00% Estimated Cost of Debt = 6.5 0.35% 0.499999 9.2 0.50% 4.799999 0.00% 1. 2 if smaller or riskier firm.8 1.25% 19.25 2.30% 1.499999 3.00% 80% 10.00% 8.50% 2.00% For large or stable firms If interest coverage ratio is > ≤ to -100000 0.50% 2.5 100000 Rating is D C CC CCC BB B+ BB BB+ BBB AA A+ AA AAA Spread is ankruptcy Probability B 20.499999 2.25 5.01% .5 1.499999 12.5 2.85% 0.Inputs for synthetic rating estimation Enter the type of firm = 2 (Enter 1 if large manufacturing firm.67 Estimated Bond Rating = BB+ Estimated Default Spread = 2.00% 80% 10.41% 0.20% 2.749999 1.00% 1.50% 0.249999 1.00% 7.00% 6.499999 1.5 9.40% 0.00% 1.00% 50.25% 19.

or riskier 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) .

00% C 0.5 100000 0.00% D -100000 0.00% A+ 7.00% 1.696 Risk Premium = 4.36% B1.799999 12.8 1.00% CC 0.892 $1.70% 0.67 AAA 12.30% $1.249999 10.999999 3.5 2.5 5.25 1.5 12. Change them in the input sheet if necessary: Ratings comparison at current debt ratio Rating Coverage gt and lt Spread Defaul t ProbCurrent Interest coverage ratio = 3.50% CCC 1.85% 0.00%= Rate Pre-tax cost of debt = 5.499999 0.CAPITAL STRUCTURE 17 Walt Disney Capital Structure Current MV of Equity = $55.00% 100.30% BB 3 3.499999 20.25% 19.499999 0.915 # of Shares Outstanding = 2475.5 9.00% 80.53% Current interest rate on debt = 5.093 Debt Value of Operating leases (if any) $1.40% Current rating for company = BBB+ A 6 7.499999 2.28% Interest rate based upon coverage = 6.50% 0.25% Income Statement Current EBITDA = Current Depreciation = Current Tax Rate = Current Capital Spending= Current Interest Expense = $3.999999 6.00% 65.5 0.00% 32.077 37.01% Rating based upon coverage = BB+ AA 9.50% 12.499999 0.499999 4.499999 8.50% 2.5 1.499999 1.35% 0.20% B+ 2.82% Financial Market Current Beta for Stock = 1.00% BBB 4 4.00% .25% A4.00% 50.28% B 2 2.25 Current Bond Rating = BBB+ Summary of Inputs Long Term Government Bond4.049 $768 We use the following default spreads in our analysis.41% Current Bankruptcy Probability = 7.101 Market Value of interest-bearing debt = $12.00% 26.999999 1.

00% 100.45 3.077 $2.04 CC 14.892 $1.659) ($6.9999999 4 4.00% 14.077 $2.499999 0.00% 80.815 $2.00% 32.30% $3.50% 2.320 $1.15% $3.349 $503 $846 $1.077 $223 0.077 $2.975) 0.00% 150.00% 70. cov ∞ Funds/Debt ∞ Likely Rating AAA Pre-tax cost of debt 4.00% 5.63% $3.466 $1.799999 0. Tax Rate 37.32% 80.00% 18 D/(D+E) D/E $ Debt Beta Cost of Equity EBITDA Depreciation EBIT Interest Taxable Income Tax Net Income (+)Deprec'n Funds from Op.914 $27.856 $41.411) ($4.Bond rate= $1.40% 37.892 $1.97 0.951 ($8.00% 12.815 $10.36% 7.36 1.00% 50.620 7.30% 13.787) ($3.176 ($1.00% 9.30% Current Equity= Current EBITDA= Current Rating= $55.815 $1.00% 10.00% 60.077 $2.00% 7.5 3.22 -0.499999 2.28% 6.543 $1.885 $34.077 $2.077 $2.5 0.77% $3.035) ($5.00% 8.14% $3.892 $1.80% 19.94 0.106 $786 $1.80% $3.00% 0.53% 11.95% 10.077 $2.003) $1.00% 65.842 10.892 BBB+ Current Depreciation= Current Interest rate (Company)= Current T.463) ($2.00% 26.150) $1.077 ($5.00% 100.999999 2 2.32% Pre-tax Int.077 $1.815 $12.050 $1.923 1.00% 100.09 B10.25 $14.790) ($1.136) ($3.892 $1.87 2.86% 66.30 -0.00% $62.00% 42.815 $9.892 $1.00% 11.67% 100.11% $6.00% 13.88 51.35% Probability of Bankruptcy 0.741 9.00% 400.00% 15.50% 37.30% $3.077 $2.101) $1.460 $918 $1.249999 1.06 D 24.942 $20.8 1.892 $1.762 $53 $20 $33 $1.809) ($3.892 $1.24 1.50% 8.14 9.07 D 24.00% 40.499999 3.815 $709 $2.999999 3 3.67 0.00% $55.073) 0.38 A+ 4.892 $1.815 $0 $2.01 C 16.93 27.815 $7.00% 11.00% 37.26 -0.077 $2.077 ($4.00% 37.00% 100.397 3.00% 30.499999 1.077 $2.00% 65.5 1.92 0.25% 19.052) $1.077 ($1.362) ($508) ($854) $1.101 $3.077 $2.08 D 24.5 2.02 0.00% 25.624 ($9.05 D 24.37 -0.827 $48.51% $3.815 $4.00% 233.CAPITAL STRUCTURE Current beta= Current Debt= Tax rate= 1.33% $13.50% 12.077 $1.25% 4.00% 7.770 4.00% 16.892 $1.605 ($4.20% 6.278 ($6.81% $3.01% Eff.815 $1.077 $2.25 1.024) 0.30% $3.59% 90.815 $354 $2.00% 32.30% .926) 0.51 1.00% 100.798 1.077 5.30% Interest cov Interest cov Low High -100000 0.07 9.077 ($2.70% 0.00% 900.00% $0 1.611 37. 0.28 9.110 1.30% WORKSHEET FOR ESTIMATING RATINGS/INTEREST RATES 20.499999 RATING D C CC CCC BB B+ BB BB+ BBB Interest rate Bankruptcy Probability 24.077 $2.00% 50.00% 25.765 $1.00% 80.971 1.17 BB+ 6.892 $1.

712 $5.450 $1.Tax Benefit on Current Debt = + Expected Current Bankruptcy Cost = $69.00% .35% 1.220 Cost of Bankruptcy (% of Value) = Current Probability of Bankrupcy = 25% 7.5 5.5 9.CAPITAL STRUCTURE 4.999999 7.40% 0.499999 12.50% 4.41% 0.53% 0.70% 4.5 12.85% 4.00% 4.499999 9.5 6 7.28% 0.499999 100000 AA A+ AA AAA 5.01% 19 Adjusted Present Value Approach Current Value of the Firm = .

775 D 100.30% 37.482 $5. Firm Value AAA 0.395 60.942 $65.00% $13.482 $5.00% $17.954 $67.446 $65.798 $65.253 80.827 $48.762 C 80.401 CC 65.CAPITAL STRUCTURE 20 Unlevered Value of Firm = $65.30% 25.482 $5.954 $67.253 $65.00% $17.331 $63.00% $17.00% $34.347 D 100.00% $1.32% Unlevered Firm Value Tax Benefits Bond Rating Probability ofExpected Bankruptcy Cost Default Value of Levered Firm $65.00% $14.522 D 100.482 $2.50% $5.971 $13.482 $7.482 $7.770 $65.00% $48.482 $5.442 $65.00% $17.741 $65.482 $5.770 $62.122 $65.218 D 100.482 Tax Benefits Bond Rating Prob.482 $8.81% 11.482 $8.482 $2.201 BB+ 7.331 $63.00% $17.00% $12.741 Tax Rate 37.50% $5.218 D 100.40% $68 $68.025 .552 50.522 D 100.707 $53.707 $53.01% $2 $65.775 D 100.801 B32.347 D 100.482 $5.482 $5.482 $5.814 $53.025 Unlev.856 $65. of Default Bankruptcy Cost Lev.00% $27.675 $53.482 $5.237 $69.00% $12.798 $55.00% $41.59% 8.40% $68 $68.914 $65.446 30.814 $53.00% $14.480 $65.482 $10.914 $27.600 A+ 0.329 $65.14% 13.014 20.00% $62.971 $65.482 $0 AAA 0.482 Debt Ratio $ Debt 0.885 $34.395 $65.30% 37.00% $17.482 $5.762 C 80.552 $65.00% $0 10.201 BB+ 7.751 $53.00% $6.401 CC 65.237 $69.00% $1.801 B32. Firm Value $65.849 $59.00% $20.122 90.30% 37.480 $0 Debt Ratio 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% $ Debt $0 $6.675 $53.32% 9.30% 37.014 $65.600 A+ 0.00% $17.885 $65.849 $59.00% $17.942 $20.329 40.00% $55.751 $53.01% $2 $65.482 $10.442 70.827 $65.856 $41.

Sign up to vote on this title
UsefulNot useful