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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: 9-10 SEPTEMBER | LONDON
NEXT PUBLIC COURSE: 8-9 JULY| LONDON
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F1F9.com/31days FinancialModellingHandbook.com
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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:
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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
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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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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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APPROACH 1: DISCOUNTING CFADS
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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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SUSTAINABLE CASH FLOW DEFINITION: EBIT * (1 tax rate) plus DEPRECIATION AND AMORTISATION less MAINTENANCE CAPITAL EXPENDITURE
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APPROACH 2: DISCOUNTING OF SUSTAINABLE CFADS
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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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DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS PERSPECTIVE
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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
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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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DISCOUNTING OF CFADS IS A USEFUL TOOL, BUT MAY NOT PROVIDE SUFFICIENT FOCUS ON RISK FROM LENDERS PERSPECTIVE
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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
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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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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
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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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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
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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.
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