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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NEXT PUBLIC COURSE: NEXT PUBLIC COURSE:

9-10 SEPTEMBER | LONDON 8-9 JULY| LONDON
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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:

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

3 Based on optimal capital structure theory

4 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:

EBIT * (1 – tax rate)

plus DEPRECIATION AND AMORTISATION
less 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 Cost of equity
cd x (1 – t) rf + (MRP * β)

Market value of debt Market value of equity

PV(rate, nper, pmt, fv) Share price x shares

DISCOUNTING OF CFADS IS A
USEFUL TOOL, BUT MAY NOT WACC
PROVIDE SUFFICIENT FOCUS
ON RISK FROM LENDERS
MV debt MV equity
PERSPECTIVE MV debt + equity +
cd x (1 – t) x ce x
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
APPROACH 4: CREDIT RATING
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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

A STRATEGY OF MAINTAINING A CERTAIN CREDIT

RATING CAN LEAD TO A DEVIATION FROM THE OPTIMAL
CAPITAL STRUCTURE WHICH MAY HAVE A VALUATION
IMPACT.