Caps Tru

7/21/2019 Caps Tru

http://slidepdf.com/reader/full/caps-tru-56def1f07717a 1/19

PRELIMINARY STUFF AND INPUTS

Objective This spreadsheet allows you to compute the optimal capital structure for a non-financial

service firm. If you have a financial service firm use capstrfin.xls

Before you start Open preferences in excel, go into calculation options and put a check in the iteration box.

If it is already checked, leave it as is.

Inputs The inputs are primarily in the input sheet. If your company has operating leases,

use the operating lease worksheet to enter your lease or rental commitments.Units Enter all numbers in the same units (000s, millions or even billions)

Income inputs The key income inputs are EBITDA, depreciation and amortization and interest expenses.

Enter the most updated numbers you have for each (even if they are 12-month trailing

numbers). If the most recent period for which you have data has an operating income that

is abnormal, either because of extraordinary losses/gains or some other occurrence, use

an average operating income over the last few years.

From the statement of cash flows, also enter the capital spending from the recent period.

P.S: If you have negative operating income and you expect to continue having negative

operating income, your optimal debt ratio will be zero.

Balance Sheet Enter the book value of all interest-bearing debt. If you have a market value enter that

number. Alternatively, input the average maturity of the debt and I will estimate the

market value of debt.

Market Data Enter the current stock price, the current long-term government bond rate, the risk

premium you would like to use to estimate your cost of equity and the current rating for

your firm. If you do not have a rating, there is an option for you at the very bottom of

the spreadsheet to compute a synthetic rating.

Tax Rate Enter a marginal tax rate, if you can estimate it. Otherwise, use the effective tax rate.

Default Spreads This spreadsheet has interest coverage ratios, ratings and default spreads built into it in

the worksheet. This spreadsheet treats the imputed interest expense on operating leases as part of th

interest expense when computing the interest coverage ratio. You can choose between ratings for la

(firms with market capitalizations that exceed $ 5 billion is a simple cut off but you can deviate fro

a more conservatve for small or risky firms. If you want, you can change the interest

coverage ratios and ratings in these tables. READING THE OUTPUT

Summary The summary provides a picture of your firm's current cost of capital and debt ratio, andcompares it to your firm's optimal debt ratio and the cost of capital at that level. It then

uses the savings from the change in cost of capital to compute how much your firm value

will change:

- with constant savings: as the present value of a perpetuity

- with a growth rate in the savings in perpetuity

The firm value change, divided by the number of shares, yields a price change

Details The details of the calculation at each debt ratio are below the summary.

References

Corporate Finance: Theory and Practice, Chapter 18

Applied Corporate Finance: Chapter 8

7/21/2019 Caps Tru


ge firms

it)

7/21/2019 Caps Tru


Question

Q1: What do I do excel says there are circular referen

Q2: My spreadsheet has gone crazy. I get errors all o

What did I do wrong?

Q3: I am entering the inputs for my company but the

optimal numbers do not seem to change from theoriginals

Q4: I am getting an optimal debt ratio of 0%. This ca

be right. Can it?

Q5: My cost of capital at my optimal debt ratio is hig

than the current cost of capital. I thought it was supp

to be lower.

7/21/2019 Caps Tru


Answer

Go into preferences, choose calculation options and make sure the iteration box has a check in it.

I am sorry to say this, but you probably just made an input error. While you might have

fixed it, the iterations in the spreadsheet make it very sensitive and the errors will not

go away. The only fix (Sorry, sorry…) is to copy the inputs into a fresh version of the spreadsheet.

You probably forgot to check the iteration box (see Q1)

Sure. If your operating income is either negative or very low, relative to your firm value,

you can end up at an optimal debt ratio of 0%. For instance, if you have EBIT of 100 on a

firm value of 10000, a 10% debt ratio would probably push you into a C rating and give

you a very high cost of capital.

Generally, you are right. However, I would suggest that you look at three factors:

- If your optimal is just slightly higher or lower than your current debt ratio, it is possible that you

are closer to the optimal than the stated optimal. Let me explain. Assume that you are at a 24% debt ratio

and the optimal comes out to 30%. The true optimal is really somewhere around 30% since

I am constrained to work in 10% increments of the debt ratio. If the true optimal were

26%, your current debt ratio of 24% is closer to the optimal.

- Rating Differences: One of the costs of rating a company based only on the interest

coverage ratio is that the rating might be very different from the actual rating. Thus, your

current cost of capital is based upon your current rating, and the optimal is based upon

the synthetic ratings, and the two don't match, the current and the optimal cost of capital

can be mismatched. You can get around this by switching to a synthetic rating for computing

the current cost of capital (in the input sheet).

- Existing debt at low rates: I assume in the spreadsheet that existing debt gets refinanced at

the new pre-tax cost of debt at each debt ratio. Consequently, if you have a lot of old debt on

your books at much lower rates, the interest expense that I report will be much higher than

your actual interest expense. This, in turn, can affect your interest coverage ratio and rating.

This, too, you can fix by locking in debt at current rates in the input sheet.

7/21/2019 Caps Tru


Inputs

Please enter the name of the company you are analyzing: Lexmark

Financial Information

Earnings before interest, taxes and depreciation (EBITDA) $767.80

Depreciation and Amortization: $200.90

Capital Spending: $200.20

Interest expense on debt: $22.10

Tax rate on ordinary income: 27.40%

Current Rating on debt (if available): AAA

Interest rate based upon rating: 5.00%

Market Information

Number of shares outstanding: 103.5

Market price per share: $54.81

Beta of the stock: 1.27

Book value of debt: $ 149.80

Can you estimate the market value of the outstanding debt? No

If so, enter the market value of debt:

Do you want me to try and estimate market value of debt? No

If yes, enter the average maturity of outstanding debt? 0.00

Do you have any operating leases? yes

General Market Data

Current long-term (LT) government bond rate: 4.65%

Risk premium (for use in the CAPM) 4.80%

General Data

Which spread/ratio table would you like to use for your anlaysis? 1

Do you want to assume that existing debt is refinanced at the 'new' rate? yes

Do you want the firm's current rating to be adjusted to the synthetic rating? yes

7/21/2019 Caps Tru


(in percent)

(in percent)

(Yes or No)

(Yes or No)

7/21/2019 Caps Tru


pera ng easeOperating lease expenses are really financial expenses, and should be treated as such.be treated as operating expenses. This program will convert commitments to make operadjust the operating income accordingly, by adding back the imputed interest expense

Inputs

Operating lease expense in current year = $36.90

Operating Lease Commitments (From footnote to financials)

Year Commitment ! Year 1 is next year, ….

1 $ 28.40

2 $ 21.40

3 $ 16.30

4 $ 9.90

5 $ 16.90

6 and beyond $ 16.90

Pre-tax Cost of Debt = 5.40% ! If you do not have a cost of debt, use the attached

From the current financial statements, enter the following

Reported Operating Income (EBIT) = $566.90 ! This is the EBIT reported in the

Reported Interest Expenses = $22.10Output

Number of years embedded in yr 6 estimate = 1 ! I use the average lease expense o

to estimate the number of years of

Converting Operating Leases into debt

Year Commitment Present Value

1 $ 28.40 $26.94

2 $ 21.40 $19.26

3 $ 16.30 $13.92

4 $ 9.90 $8.02

5 $ 16.90 $12.996 and beyond $ 16.90 $12.33 ! Commitment beyond year 6 converted into an ann

Debt Value of leases = $ 93.47

Restated Financials

Operating Income with Operating leases reclassified as debt = $ 571.95

Interest expenses with Operating leases classified as debt = $ 27.15

7/21/2019 Caps Tru


nver erccounting standards allow them toating leases into debt andn this debt.

atings estimator

urrent income statement

ver the first five years

expenses in yr 6

ity for ten years

7/21/2019 Caps Tru


Inputs for synthetic rating estimationEnter the type of firm = 1 (Enter 1 if large manufacturing firm, 2 if smaller or

Enter current Earnings before interest and taxes (EBIT) = $571.95

Enter current interest expenses = $27.15

Enter current long term government bond rate = 4.65%

OutputInterest coverage ratio = 21.07

Estimated Bond Rating = AAA

Estimated Default Spread = 0.75%

Estimated Cost of Debt = 5.40%

For large or stable firms

If interest coverage ratio is

> ≤ to Rating is Spread is

-100000 0.199999 D 20.00%

0.2 0.649999 C 12.00%

0.65 0.799999 CC 10.00%0.8 1.249999 CCC 7.50%

1.25 1.499999 B- 6.50%

1.5 1.749999 B 5.65%

1.75 1.999999 B+ 4.50%

2 2.2499999 BB 3.65%

2.25 2.49999 BB+ 3.20%

2.5 2.999999 BBB 2.50%

3 4.249999 A- 1.70%

4.25 5.499999 A 1.50%

5.5 6.499999 A+ 1.40%

6.5 8.499999 AA 1.25%

8.50 100000 AAA 0.75%

For smaller and riskier firms

If interest coverage ratio is

greater than ≤ to Rating is Spread is

-100000 0.499999 D 20.00%

0.5 0.799999 C 12.00%

0.8 1.249999 CC 10.00%

1.25 1.499999 CCC 7.50%

1.5 1.999999 B- 6.50%

2 2.499999 B 5.65%2.5 2.999999 B+ 4.50%

3 3.499999 BB 3.65%

3.5 3.9999999 BB+ 3.20%

4 4.499999 BBB 2.50%

4.5 5.999999 A- 1.70%

6 7.499999 A 1.50%

7.5 9.499999 A+ 1.40%

9.5 12.499999 AA 1.25%

12.5 100000 AAA 0.75%

7/21/2019 Caps Tru


iskier firm, 3 if financial service firm)

(Add back only long term interest expense for financial firms)

(Use only long term interest expense for financial firms)

7/21/2019 Caps Tru


CAPITAL STRUCTURE

exmarCapital Structure Financial Market Income Statement

Current MV of Equity = $5,673 Current Beta for Stock = 1.27 Current EBITDA = $773

Market Value of interest-bearing d $150 Current Bond Rating = AAA Current Depreciation = $201

# of Shares Outstanding = 103.5 Summary of Inputs Current Tax Rate = 27.40%

Debt Value of Operating leases (if $93 Long Term Government Bond 4.65% Current Capital Spending= $200

Risk Premium = 4.80% Pre-tax cost of debt = 5.00% Current Interest Expense = $27

RESULTS FROM ANALYSISCurrent Optimal Change

D/(D+E) Ratio = 4.11% 50.00% 45.89%Implied Growth Rate Calculation

Beta for the Stock = 1.27 2.13 0.86 Value of Firm $5,916

Cost of Equity = 10.75% 14.85% 4.11% Current WAC 10.47%

Current FCFF $415.93 ! I am ignoring

AT Interest Rate on Debt = 3.92% 4.61% 0.69% Implied Growt 3.21%If this number is >Riskfree rate, I use the risk

WACC 10.47% 9.73% -0.73%

Implied Growth Rate = 3.21%

Assumes constant saving Firm Value (no growth) = $5,916 $6,362 $446Assumes perpeutal growth Firm Value (Perpetual Growth $5,916 $6,603 $686

Value/share (No Growth) = $54.81 $59.12 $4.31

Value/share (Perpetual Growt $54.81 $61.44 $6.63

We use the following default spreads in our analysis. Change them in the input sheet if necessary: Ratings comparison at current debt ratio

Rating Coverage gt and lt Spread Current Interest coverage ratio = 21.07

AAA 8.5 100000 0.75% Rating based upon coverage = AAA

AA 6.5 8.499999 1.25% Interest rate based upon coverage = 5.40%

A+ 5.5 6.499999 1.40% Current rating for company = AAAA 4.25 5.499999 1.50% Current interest rate on debt = 5.00%

A- 3 4.249999 1.70%

BBB 2.5 2.999999 2.50%

BB 2 2.2499999 3.65%B+ 1.75 1.999999 4.50%B 1.5 1.749999 5.65%

B- 1.25 1.499999 6.50%

CCC 0.8 1.249999 7.50%

CC 0.65 0.799999 10.00%C 0.2 0.649999 12.00%

D -100000 0.199999 20.00%

7/21/2019 Caps Tru


CAPITAL STRUCTURE

Current beta= 1.27 Current Equity= $5,673 Current Depreciation= $201

Current Debt= $243 Current EBITDA= $773 Current Interest rate (Company)= 5.00%

Tax rate= 27.40% Current Rating= AAA Current T.Bond rate= 4.65%

WORKSHEET FOR ESTIMATING RATINGS/INTEREST RATES

D/(D+E) 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00%

D/E 0.00% 11.11% 25.00% 42.86% 66.67% 100.00% 150.00% 233.33% 400.00% 900.00%

$ Debt $0 $592 $1,183 $1,775 $2,366 $2,958 $3,550 $4,141 $4,733 $5,324

Beta 1.23 1.33 1.46 1.61 1.83 2.13 2.57 3.32 4.82 10.36

Cost of Equity 10.56% 11.04% 11.63% 12.40% 13.42% 14.85% 17.00% 20.58% 27.77% 54.36%

EBITDA $773 $773 $773 $773 $773 $773 $773 $773 $773 $773

Depreciation $201 $201 $201 $201 $201 $201 $201 $201 $201 $201

EBIT $572 $572 $572 $572 $572 $572 $572 $572 $572 $572

Interest $0 $32 $64 $109 $150 $188 $325 $503 $575 $887

Taxable Income $572 $540 $508 $463 $422 $384 $247 $69 ($3) ($315)Tax $157 $148 $139 $127 $116 $105 $68 $19 ($1) ($86)

Net Income $415 $392 $369 $336 $306 $279 $179 $50 ($2) ($228)

(+)Deprec'n $201 $201 $201 $201 $201 $201 $201 $201 $201 $201

Funds from Op. $616 $593 $570 $537 $507 $480 $380 $251 $199 ($27)

Pre-tax Int. cov ∞ 17.90 8.95 5.24 3.81 3.04 1.76 1.14 0.99 0.65

Funds/Debt ∞ 1.00 0.48 0.30 0.21 0.16 0.11 0.06 0.04 -0.01

Likely Rating AAA AAA AAA A A- A- B+ CCC CCC C

Pre-tax cost of deb 5.40% 5.40% 5.40% 6.15% 6.35% 6.35% 9.15% 12.15% 12.15% 16.65%

Eff. Tax Rate 27.40% 27.40% 27.40% 27.40% 27.40% 27.40% 27.40% 27.40% 27.25% 17.68%COST OF CAPITAL CALCULATIONS

D/(D+E) 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00%

D/E 0.00% 11.11% 25.00% 42.86% 66.67% 100.00% 150.00% 233.33% 400.00% 900.00%

$ Debt $0 $592 $1,183 $1,775 $2,366 $2,958 $3,550 $4,141 $4,733 $5,324

Cost of equity 10.56% 11.04% 11.63% 12.40% 13.42% 14.85% 17.00% 20.58% 27.77% 54.36%

Cost of debt 3.92% 3.92% 3.92% 4.46% 4.61% 4.61% 6.64% 8.82% 8.84% 13.71%

Cost of Capital 10.56% 10.33% 10.09% 10.02% 9.90% 9.73% 10.79% 12.35% 12.62% 17.77%

Value (no growth) $5,862 $5,995 $6,135 $6,179 $6,255 $6,362 $5,740 $5,014 $4,904 $3,484

Value (perpetual g $5,836 $6,035 $6,247 $6,315 $6,434 $6,603 $5,658 $4,658 $4,516 $2,852

7/21/2019 Caps Tru


CAPITAL STRUCTURE

Interest cov Interest cov RATING Interest rate

Low High-100000 0.199999 D 24.65%

0.2 0.649999 C 16.65%

0.65 0.799999 CC 14.65%0.8 1.249999 CCC 12.15%

1.25 1.499999 B- 11.15%1.5 1.749999 B 10.30%

1.75 1.999999 B+ 9.15%2 2.2499999 BB 8.30%

2.25 2.49999 BB+ 7.85%2.5 2.999999 BBB 7.15%3 4.249999 A- 6.35%

4.25 5.499999 A 6.15%5.5 6.499999 A+ 6.05%6.5 8.499999 AA 5.90%

8.5 100000 AAA 5.40%

7/21/2019 Caps Tru


CAPITAL STRUCTURE

working capital

free rate as a perpetual growth rate.

7/21/2019 Caps Tru


CAPITAL STRUCTURE 21

7/21/2019 Caps Tru


CAPITAL STRUCTURE 22

7/21/2019 Caps Tru


Chart - Cost of Equity

Page 23

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

0.00

2.00

4.00

6.00

8.00

10.00

12.00

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Cost of Equity and Beta: Debt Ratios

Beta

Cost of Equity

7/21/2019 Caps Tru


Debt Ratio Beta Cost of Equity Bond Rating nterest rate on deb Tax Rate

0% 1.23 10.56% AAA 5.40% 27.40%

10% 1.33 11.04% AAA 5.40% 27.40%

20% 1.46 11.63% AAA 5.40% 27.40%

30% 1.61 12.40% A 6.15% 27.40%

40% 1.83 13.42% A- 6.35% 27.40%

50% 2.13 14.85% A- 6.35% 27.40%

60% 2.57 17.00% B+ 9.15% 27.40%

70% 3.32 20.58% CCC 12.15% 27.40%

80% 4.82 27.77% CCC 12.15% 27.25%

90% 10.36 54.36% C 16.65% 17.68%

7/21/2019 Caps Tru


ost of Debt (after-tax WACC Firm Value (G)

3.92% 10.56% $5,836

3.92% 10.33% $6,035

3.92% 10.09% $6,247

4.46% 10.02% $6,315

4.61% 9.90% $6,434

4.61% 9.73% $6,603

6.64% 10.79% $5,658

8.82% 12.35% $4,658

8.84% 12.62% $4,516

13.71% 17.77% $2,852

Documents

Caps Tru