Professional Documents
Culture Documents
Restructuring Debt and Equity
Restructuring Debt and Equity
Giddy/NYU
Restructuring
Debt and Equity
Prof. Ian Giddy
New York University
z
z
z
z
Corporate restructuring
business and financial
Structured financing
techniques
Distress-induced
restructuring
Mergers, divestitures and
LBOs
Ian H. Giddy/NYU
Estimating
Argus case
z TDI case
z
Case Studies
SAP (optimizing the capital structure)
z Argus (application to a private firm)
z TDI (sequence of financial and
operational restructuring efforts)
z
Ian H. Giddy/NYU
Estimating
Kodak
Kodak
Source: Bloomberg.com
Copyright 2004 Ian H. Giddy
Ian H. Giddy/NYU
Kodak
Kodak
Source: morningstar.com
Copyright 2004 Ian H. Giddy
Merck
Merck
Merck:
Merck:
P/E
P/E16
16
Market
MarketCap
Cap$112b
$112b
Source: morningstar.com
Copyright 2004 Ian H. Giddy
Ian H. Giddy/NYU
Nokia
Nokia
Nokia:
Nokia:
P/E
P/E34
34
Market
MarketCap
Cap$70b
$70b
Source: morningstar.com
Copyright 2004 Ian H. Giddy
Cost
of equity
Cost of debt
Weighted average (WACC)
Copyright 2004 Ian H. Giddy
Ian H. Giddy/NYU
Assets
Liabilities
Debt
Uncertain
Uncertain
value
value
of
offuture
future
cash
cash flows
flows
Contractual
Contractualint.
int.&&principal
principal
No
Noupside
upside
Senior
Seniorclaims
claims
Control
Controlvia
viarestrictions
restrictions
Equity
Residual
Residualpayments
payments
Upside
Upsideand
anddownside
downside
Residual
claims
Residual claims
Voting
Votingcontrol
controlrights
rights
Corporate Financial Restructuring 12
Ian H. Giddy/NYU
Cost of debt =
kd = LT Borrowing Rate(1 - Tax rate)
The cost of debt is not
z
z
If the firm has bonds outstanding, and the bonds are traded, the
yield to maturity on a long-term, straight (no special features)
bond can be used as the interest rate.
If the firm is rated, use the rating and a typical default spread on
bonds with that rating to estimate the cost of debt.
If the firm is not rated,
and it has recently borrowed long term from a bank, use the interest
rate on the borrowing or
estimate a synthetic rating for the company, and use the synthetic
rating to arrive at a default spread and a cost of debt
Ian H. Giddy/NYU
AAA
AA
BBB
BB
CCC
13.50
9.67
5.76
3.94
2.14
1.51
0.96
17.08
12.80
8.18
6.00
3.49
2.45
1.51
98.2%
69.1%
45.5%
33.3%
17.7%
11.2%
6.7%
60.0%
26.8%
20.9%
7.2%
1.4%
1.2%
0.96%
29.3%
21.4%
19.1%
13.9%
12.0%
7.6%
5.2%
22.6%
17.8%
15.7%
13.5%
13.5%
12.5%
12.2%
13.3%
21.1%
31.6%
42.7%
55.6%
62.2%
69.5%
25.9%
33.6%
39.7%
47.8%
59.4%
67.4%
69.1%
Ian H. Giddy/NYU
Cost of Capital
Cost
Amount
Weight
Debt
10-year bond yield
Tax rate
After-tax cost
4.95%
29%
3.5%
61.9
31%
Risk-free Treasury
Beta
Market Risk Premium
From CAPM
4.50%
1.47
5.50%
12.6%
137.4
69%
9.77%
199.3
Equity
Total
Source: IBMfinancing.xls
Ian H. Giddy/NYU
In practice,
Long term government bond rates are used as risk free rates
Historical risk premiums are used for the risk premium
Betas are estimated by regressing stock returns against market
returns
Ian H. Giddy/NYU
Debt
Estimated Beta
With current leverage
From regression
Leverage, EBITDA
And interest cost
Unlevered Beta
With no leverage
Bu=Bl/(1+D/E(1-T))
Interest Coverage
EBITDA/Interest
Levered Beta
With different leverage
Bl=Bu(1+D/E(1-T))
Rating
(other factors too!)
Cost of equity
With different leverage
E(R)=Rf+Bl(Rm-Rf)
Cost of debt
With different leverage
Rate=Rf+Spread+?
Cost
1. Equity
- Retained earnings
- New stock issues
- Warrants
Cost of equity
- depends upon riskiness of the stock
- will be affected by level of interest rates
Cost of debt
- depends upon default risk of the firm
- will be affected by level of interest rates
- provides a tax advantage because interest is tax-deductible
Ian H. Giddy/NYU
Cost of Capital
Cost
Amount
Weight
Debt
10-year bond yield
Tax rate
After-tax cost
4.95%
29%
3.5%
61.9
31%
Risk-free Treasury
Beta
Market Risk Premium
From CAPM
4.50%
1.47
5.50%
12.6%
137.4
69%
9.77%
199.3
Equity
Total
Source: IBMfinancing.xls
Ian H. Giddy/NYU
Cost of Equity
16.95%
17.76%
18.77%
20.07%
21.81%
24.24%
29.16%
37.29%
52.94%
99.87%
Bond Rating
AAA
AA
AB+
BCCC
CC
C
C
C
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
0%
Tax Rate
33.45%
33.45%
33.45%
33.45%
33.45%
33.45%
25.67%
20.38%
17.83%
15.85%
Value ($millions)
Cost of Capital
Debt Ratio
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
20%
40%
60%
80%
100%
WACC
16.95%
16.78%
16.71%
16.90%
17.41%
17.86%
20.02%
22.47%
23.90%
25.32%
1200
1000
800
600
400
200
0
0%
20%
40%
60%
80%
100%
Debt Percentage
Debt Percentage
Debt
0
2500
5000
7500
10000
z
z
z
Rating
AAA
AAA
A
AB+
Interest Interest
rate expense
5.65%
11
5.65%
153
6.37%
331
6.56%
505
10.90%
1,112
Debt /
Interest
coverage capitaliz Debt/book
ation
equity
ratio
138.76
1%
0.1
10.28
7%
0.7
4.73
14%
1.4
3.10
21%
2.1
1.41
27%
2.7
Ian H. Giddy/NYU
Links
Useful Links
Company information: biz.yahoo.com/ifc
Industry ratios: www.stern.nyu.edu/~adamodar
Debt ratings and spreads: bondsonline.com
Ian H. Giddy/NYU
2.
3.
Ian H. Giddy/NYU
Ian H. Giddy/NYU
Project Risk
Competitive Risk
Sector Risk
Cares about
Total
Risk
Risk Measure
Standard
Deviation
Cost of
Equity
Firm Value
40%
100/.4=250
Intnl Risk
Market Risk
Project Risk
Competitive Risk
Sector Risk
Intnl Risk
Risk added to
sector
portfolio
Beta
relative to
sector
25%
100/.25=400
Risk added to
domestic
portfolio
Beta
relative to
local index
15%
100/.15=667
Risk added to
global
portfolio
Beta
relative to
global
index
10%
100/.10=1000
Market Risk
Publicly traded company
with investors who are
diversified domestically
or
IPO to investors who are
domestically diversified
Project Risk
Competitive Risk
Sector Risk
Intnl Risk
Market Risk
Project Risk
Competitive Risk
Sector Risk
Intnl Risk
Market Risk
Ian H. Giddy/NYU
Cost of Capital
for a Private
Company:
Example
Comparable Companies
Firm 1
Firm 2
Firm 3
DATA
200
100
40%
1.45
200
200
35%
1.90
300
200
38%
1.70
RESULT
1+ (1-T)D/E
Unlevered equity beta
1.30
1.12
1.65
1.15
1.41
1.20
Average
Input cells are in yello
1.16
Private Company
DATA
% Debt
% Equity
Tax rate
20%
80% Estimate value of equity from P/E of comparables
40%
1+ (1-T)D/E
Multiply unlevered project beta
1.15
1.16
1.33
DATA
Risk-free rate
Market risk premium
6.00%
7.50%
RESULT
RESULT
1.33
7.50%
9.98%
6.00%
15.98%
Note: The estimate of the market risk premium is the arithmetic average from 1927-1998, based on
the Ibbotson Associates "Stocks, Bonds, Bills and Inflation" data.
DATA
Cost of debt
RESULT
Weights
After-tax cost of debt
Cost of equity
Weighted average cost of capital
7.8%
16.0%
Weighted
Cost
20.0%
80.0%
1.6%
12.8%
14.3%
Debt Ratio
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Bond Rating
AA
AA
BBB
B+
BCC
CC
C
C
C
Interest Rate
7.50%
7.50%
8.50%
9.50%
11.25%
13.00%
13.00%
14.50%
14.50%
14.50%
AT Cost of Debt
4.35%
4.35%
4.93%
5.51%
6.53%
7.54%
7.96%
10.18%
10.72%
11.14%
Cost of Capital
12.65%
12.15%
11.76%
11.49%
11.51%
11.73%
11.91%
13.70%
14.45%
15.20%
Firm Value
$26,781
$29,112
$31,182
$32,803
$32,679
$31,341
$30,333
$22,891
$20,703
$18,872
Ian H. Giddy/NYU
1. Tax Rate
Higher tax rates - - > Higher Optimal Debt Ratio
Lower tax rates - - > Lower Optimal Debt Ratio
2. Pre-Tax Returns on Firm = (Operating Income) / MV of Firm
Higher Pre-tax Return- - > Higher Optimal Debt Ratio
Lower Pre-tax Returns- - > Lower Optimal Debt Ratio
3. Variance in Earnings [Shows up when you do 'what if' analysis]
Higher Variance - - > Lower Optimal Debt Ratio
Lower Variance - - > Higher Optimal Debt Ratio
Macro-Economic Factors
Default Spreads
Higher
Lower
Ian H. Giddy/NYU
Nexus of Contracts
Franchisors
Senior lenders
Salespeople
Subordinated
lenders
Management
Shareholders
Contact Info
Ian H. Giddy
NYU Stern School of Business
Tel 212-998-0426; Fax 212-995-4233
Ian.giddy@nyu.edu
http://giddy.org