WWW.F1F9.COM

DEBT SIZING IN EXCEL

WWW.F1F9.COM 2

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

WWW.F1F9.COM 3

NEXT PUBLIC COURSE: 9-10 SEPTEMBER | LONDON

NEXT PUBLIC COURSE: 8-9 JULY| LONDON

WWW.F1F9.COM 4

ASK DOWNLOAD TWEET

@F1F9

WWW.F1F9.COM

5

F1F9.com/31days FinancialModellingHandbook.com

WWW.F1F9.COM 6

FIONA COLLINSON

WWW.F1F9.COM

7

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

WWW.F1F9.COM

DEBT SIZING METHODS:

8

1

2

3

4

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

Based on optimal capital structure theory

Based on credit rating

WWW.F1F9.COM

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

9

WWW.F1F9.COM

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

10

APPROACH 1: DISCOUNTING CFADS

WWW.F1F9.COM

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

11

WWW.F1F9.COM

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

12

WWW.F1F9.COM

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

13

WWW.F1F9.COM

SUSTAINABLE CASH FLOW DEFINITION: EBIT * (1 tax rate) plus DEPRECIATION AND AMORTISATION less MAINTENANCE CAPITAL EXPENDITURE

14

APPROACH 2: DISCOUNTING OF SUSTAINABLE CFADS

WWW.F1F9.COM

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.

15

WWW.F1F9.COM

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

16

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

WWW.F1F9.COM

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

17

WWW.F1F9.COM

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

18

WACC CALCULATION Cost of debt cd x (1 t)

Cost of equity rf + (MRP * )

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

Market value of equity Share price x shares

WACC

cd x (1 t) x MV debt MV debt + equity

+ ce x MV equity MV debt + equity

WWW.F1F9.COM

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

19

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

THIS IS ALSO THE POINT WHERE THE VALUE OF THE FIRM IS MAXIMISED

WWW.F1F9.COM

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

20

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

THIS IS ALSO THE POINT WHERE THE VALUE OF THE FIRM IS MAXIMISED

APPROACH 4: CREDIT RATING

WWW.F1F9.COM

21

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.

Slide Number 1Slide Number 2Slide Number 3Slide Number 4Slide Number 5Slide Number 6Slide Number 7Slide Number 8Slide Number 9Slide Number 10Slide Number 11Slide Number 12Slide Number 13Slide Number 14Slide Number 15Slide Number 16Slide Number 17Slide Number 18Slide Number 19Slide Number 20Slide Number 21