If default risk is added to the cost of debt, we are deeming that the lender bears the risk. But, actually, the lender shall be paid first and so, the risk should be borne by the equity holders. Further, the same has already been accounted for while calculating the leveraged beta. Wouldn't it amount to giving double effect to the default risk on loan?
If the company goes bankrupt and if it is so terrible that it has literally 0 value( or in most case, their assets can not pay the full debt), even the lender can not have the money back. So lender carries the risk. Or you can think it another way, if lenders do not have risk, then every company should have same interest rate for debt.
"The link between interest coverage ratios and ratings was developed by looking at all rated companies in the United States. The default spreads are obtained from traded bonds. Adding that number to a riskfree rate should yield the pre-tax cost of borrowing for a firm." from : pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ratings.htm I guess specific interest coverage values are averages or medians.
He looked at which metric was best related to the actual debt rating provided by agencies, and made a chart based of it. So if Net debt/ebitda explained the relationship to the actual debt rating from agencies, we would use that instead of what he currently uses, the interest coverage ratio
So far, the interest coverage ratio is the most reliable metric that explains how rating agencies give out firm credit ratings. In reality, credit ratings use all type of metrics, but we try to find one that best explains it
According to the definition of financial expenses, classical rent for buildings would also be debt - I would definitely not agree with that. So I would rather disagree with your definition of financial expense. There are two simple points to be considered: 1) multiple payments over time 2) contractual payment (good and bad times) These criteria are met by too many things. As a financial service company, subscriptions to information services would count as debt, even though they are obviously operating expenses. Please correct me if I misunderstand. I would also like to know whether we consider the adjusted debt in our D/E Ratio. If yes, I really do wonder, as we are considering it with our cost of borrowing on market terms and in our cost of capital. I would assume that leases, for example car pool leases are most likely less expensive and wouldn't be "bought" in the same sense as tradable debt would be. I would also appreciate opinions on this thought. In cases of leases the treatment makes sense, as a) in most cases the company can buy the asset at the end of the leasing contract for the rest of the assets price and b) leasing contracts usually are more long term than classical rent contracts. Classical rent of buildings for example a) can be canceled within a much shorter time frame and b) at the end of the contract I do not own any asset or something.
Professor Damodaran, is there any calculation for portion of country default spread in cost of debt of the company, or we should rely on rough estimate , how much company's activities depends of economic situation of the country it's based?
I'm a bad student, I'm not in a group yet, and I haven't picked a company. Or I am a very good studient, I'm in my own group of 1, and I've picked a few compnaiesd which are in my portfolio. Which one am I? I need to do a valuation to find out.
Reference (video at 6:36)- As per IAS 38, the R & D Expenses in the development phase will be added to the cost of intangible asset i.e. to be capitalized.
Can someone explain the straight debt equation at 52:28 because I can't get the output on my calculator no matter how I type it. Is it ((125*0.04)*10)+(125/(1.08^10))? Because that equals 107.89 - Very grateful for any help!
@@jaivarma1984 Hey Jai, appreciate the help but I think you may have typed out the wrong thing after the 5mn( I'm assuming 1/8% - 1/8% is not what you meant - would you mind telling me what was? Thanks in advance!
@@jaivarma1984 I think maybe this is what you meant? 5*((140-125)/(1.08^10)) + 125/1.08^10 =92.64 Note that's still over a million more than Aswath's answer :/
Hi, no i did mean the above formula & it does spit out 91 million. So annuity formula: Coupon(1/r -1/r(1+r)^T) + Face value/(1+r)^T. The above just inputs the numbers into this formula. Hope this helps.
If default risk is added to the cost of debt, we are deeming that the lender bears the risk. But, actually, the lender shall be paid first and so, the risk should be borne by the equity holders. Further, the same has already been accounted for while calculating the leveraged beta. Wouldn't it amount to giving double effect to the default risk on loan?
If the company goes bankrupt and if it is so terrible that it has literally 0 value( or in most case, their assets can not pay the full debt), even the lender can not have the money back. So lender carries the risk. Or you can think it another way, if lenders do not have risk, then every company should have same interest rate for debt.
Prof Damodaran, how did you come up with the synthetic rating lookup table? Thank you for sharing your knowledge with us btw
"The link between interest coverage ratios and ratings was developed by looking at all rated companies in the United States. The default spreads are obtained from traded bonds. Adding that number to a riskfree rate should yield the pre-tax cost of borrowing for a firm." from : pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ratings.htm
I guess specific interest coverage values are averages or medians.
He looked at which metric was best related to the actual debt rating provided by agencies, and made a chart based of it. So if Net debt/ebitda explained the relationship to the actual debt rating from agencies, we would use that instead of what he currently uses, the interest coverage ratio
So far, the interest coverage ratio is the most reliable metric that explains how rating agencies give out firm credit ratings. In reality, credit ratings use all type of metrics, but we try to find one that best explains it
According to the definition of financial expenses, classical rent for buildings would also be debt - I would definitely not agree with that. So I would rather disagree with your definition of financial expense.
There are two simple points to be considered:
1) multiple payments over time
2) contractual payment (good and bad times)
These criteria are met by too many things. As a financial service company, subscriptions to information services would count as debt, even though they are obviously operating expenses. Please correct me if I misunderstand.
I would also like to know whether we consider the adjusted debt in our D/E Ratio. If yes, I really do wonder, as we are considering it with our cost of borrowing on market terms and in our cost of capital. I would assume that leases, for example car pool leases are most likely less expensive and wouldn't be "bought" in the same sense as tradable debt would be. I would also appreciate opinions on this thought.
In cases of leases the treatment makes sense, as a) in most cases the company can buy the asset at the end of the leasing contract for the rest of the assets price and b) leasing contracts usually are more long term than classical rent contracts. Classical rent of buildings for example a) can be canceled within a much shorter time frame and b) at the end of the contract I do not own any asset or something.
Professor Damodaran, is there any calculation for portion of country default spread in cost of debt of the company, or we should rely on rough estimate , how much company's activities depends of economic situation of the country it's based?
I'm a bad student, I'm not in a group yet, and I haven't picked a company.
Or I am a very good studient, I'm in my own group of 1, and I've picked a few compnaiesd which are in my portfolio.
Which one am I? I need to do a valuation to find out.
Reference (video at 6:36)- As per IAS 38, the R & D Expenses in the development phase will be added to the cost of intangible asset i.e. to be capitalized.
Can someone explain the straight debt equation at 52:28 because I can't get the output on my calculator no matter how I type it. Is it ((125*0.04)*10)+(125/(1.08^10))? Because that equals 107.89 - Very grateful for any help!
5mn(1/8% - 1/8%(1+8%)^10) + 125/1+8%^10
@@jaivarma1984 Hey Jai, appreciate the help but I think you may have typed out the wrong thing after the 5mn( I'm assuming 1/8% - 1/8% is not what you meant - would you mind telling me what was? Thanks in advance!
@@jaivarma1984 I think maybe this is what you meant?
5*((140-125)/(1.08^10)) + 125/1.08^10 =92.64 Note that's still over a million more than Aswath's answer :/
Hi, no i did mean the above formula & it does spit out 91 million. So annuity formula: Coupon(1/r -1/r(1+r)^T) + Face value/(1+r)^T. The above just inputs the numbers into this formula. Hope this helps.
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