Debt collection ppt

debt market instruments ppt and debt vs equity financing ppt and public debt management ppt
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Prof.KristianHardy,Austria,Teacher
Published Date:26-07-2017
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Aswath Damodaran 1 GETTING  TO  THE  OPTIMAL:   TIMING  AND  FINANCING   CHOICES   You  can  take  it  slow..  Or  perhaps  not…  Big  Picture…   2 Maximize the value of the business (firm) The Investment Decision The Dividend Decision The Financing Decision Invest in assets that earn a If you cannot find investments Find the right kind of debt return greater than the that make your minimum for your firm and the right minimum acceptable hurdle acceptable rate, return the cash mix of debt and equity to rate to owners of your business fund your operations The hurdle rate How much The return How you choose The optimal The right kind should reflect the should reflect the cash you can to return cash to mix of debt of debt riskiness of the return magnitude and the owners will and equity matches the investment and the timing of the depends upon depend on maximizes firm tenor of your the mix of debt cashflows as welll current & whether they value assets and equity used potential as all side effects. prefer dividends to fund it. investment or buybacks opportunities Aswath Damodaran 2 Now  that  we  have  an  opGmal..  And  an  actual..   What  next?   3 ¨  At  the  end  of  the  analysis  of  financing  mix  (using   whatever  tool  or  tools  you  choose  to  use),  you  can   come  to  one  of  three  conclusions:   1.  The  firm  has  the  right  financing  mix   2.  It  has  too  liUle  debt  (it  is  under  levered)   3.  It  has  too  much  debt  (it  is  over  levered)   ¨  The  next  step  in  the  process  is   ¤ Deciding  how  much  quickly  or  gradually  the  firm  should   move  to  its  opGmal   ¤ Assuming  that  it  does,  the  right  kind  of  financing  to  use  in   making  this  adjustment   Aswath Damodaran 3 A  Framework  for  GeZng  to  the  OpGmal   4 Is the actual debt ratio greater than or lesser than the optimal debt ratio?" Actual Optimal" Actual Optimal" Overlevered" Underlevered" Is the firm under bankruptcy threat?" Is the firm a takeover target?" Yes" No" Yes" No" Reduce Debt quickly" Increase leverage" Does the firm have good " Does the firm have good " 1. Equity for Debt swap" quickly" projects?" projects?" 2. Sell Assets; use cash" 1. Debt/Equity swaps" ROE Cost of Equity" ROE Cost of Equity" to pay off debt" 2. Borrow money&" ROC Cost of Capital" ROC Cost of Capital" 3. Renegotiate with lenders" buy shares." Yes" No" Yes" No" Take good projects with" 1. Pay off debt with retained" Take good projects with" new equity or with retained" earnings." debt." earnings." 2. Reduce or eliminate dividends." Do your stockholders like" 3. Issue new equity and pay off " dividends?" debt." Yes" No" Pay Dividends" Buy back stock" Aswath Damodaran 4 Disney:  Applying  the  Framework   Is the actual debt ratio greater than or lesser than the optimal debt ratio?" Actual Optimal" Actual Optimal Overlevered" Actual (11.58%) Optimal (40%) Is the firm under bankruptcy threat?" Is the firm a takeover target?" No. Large mkt cap & positive Yes" No" Yes" Jensen’s α Reduce Debt quickly" Increase leverage" Does the firm have good " Does the firm have good " 1. Equity for Debt swap" quickly" projects?" projects?" 2. Sell Assets; use cash" 1. Debt/Equity swaps" ROE Cost of Equity" ROE Cost of Equity" to pay off debt" 2. Borrow money&" ROC Cost of Capital" ROC Cost of Capital" 3. Renegotiate with lenders" buy shares." Yes" No" Yes. ROC Cost of capital" No" Take good projects with" 1. Pay off debt with retained" Take good projects new equity or with retained" earnings." With debt. earnings." 2. Reduce or eliminate dividends." Do your stockholders like" 3. Issue new equity and pay off " dividends?" debt." Yes" No" Pay Dividends" Buy back stock" 5 6  ApplicaGon  Test:  GeZng  to  the  OpGmal   6 ¨  Based  upon  your  analysis  of  both  the  firm’s  capital   structure  and  investment  record,  what  path  would   you  map  out  for  the  firm?   a.  Immediate  change  in  leverage   b.  Gradual  change  in  leverage   c.  No  change  in  leverage   ¨  Would  you  recommend  that  the  firm  change  its   financing  mix  by     a.  Paying  off  debt/Buying  back  equity   b.  Take  projects  with  equity/debt   Aswath Damodaran 6 The  Mechanics  of  Changing  Debt  RaGo  quickly…   7 To decrease the debt ratio Issue new stock to retire Sell operating assets debt or get debt holders to and use cash to pay accept equity in the firm. down debt. Assets Liabilities Cash Debt Opearing Assets in place Equity Growth Assets Sell operating assets Borrow money and buy and use cash to buy back stock or pay a large back stock or pay or special dividend special dividend To increase the debt ratio Aswath Damodaran 7 The  mechanics  of  changing  debt  raGos  over   Gme…  gradually…   8 ¨  To  change  debt  raGos  over  Gme,  you  use  the  same  mix   of  tools  that  you  used  to  change  debt  raGos  gradually:   ¤  Dividends  and  stock  buybacks:  Dividends  and  stock  buybacks   will  reduce  the  value  of  equity.   ¤  Debt  repayments:  will  reduce  the  value  of  debt.   ¨  The  complicaGon  of  changing  debt  raGos  over  Gme  is   that  firm  value  is  itself  a  moving  target.     ¤  If  equity  is  fairly  valued  today,  the  equity  value  should  change   over  Gme  to  reflect  the  expected  price  appreciaGon:   ¤  Expected  Price  appreciaGon  =  Cost  of  equity  –  Dividend  Yield   ¤  Debt  will  also  change  over  Gme,  in  conjuncGon  as  firm  value   changes.   Aswath Damodaran 8 Designing  Debt:  The  Fundamental  Principle   9 ¨  The  objecGve  in  designing  debt  is  to  make  the  cash   flows  on  debt  match  up  as  closely  as  possible  with   the  cash  flows  that  the  firm  makes  on  its  assets.   ¨  By  doing  so,  we  reduce  our  risk  of  default,  increase   debt  capacity  and  increase  firm  value.   Aswath Damodaran 9 Firm  with  mismatched  debt   10 Firm Value Value of Debt Aswath Damodaran 10 Firm  with  matched  Debt   11 Firm Value Value of Debt Aswath Damodaran 11 Design  the  perfect  financing  instrument   12 ¨  The  perfect  financing  instrument  will   ¤ Have  all  of  the  tax  advantages  of  debt   ¤ While  preserving  the  flexibility  offered  by  equity   Start with the Cyclicality & Cash Flows Growth Patterns Other Effects on Assets/ Duration Currency Effect of Inflation Projects Uncertainty about Future Fixed vs. Floating Rate Straight versus Special Features Commodity Bonds More floating rate Convertible on Debt Catastrophe Notes Duration/ Currency - if CF move with - Convertible if - Options to make Define Debt Maturity Mix inflation cash flows low cash flows on debt Characteristics - with greater uncertainty now but high match cash flows on future exp. growth on assets Design debt to have cash flows that match up to cash flows on the assets financed Aswath Damodaran 12 Ensuring  that  you  have  not  crossed  the  line   drawn  by  the  tax  code   13 ¨  All  of  this  design  work  is  lost,  however,  if  the   security  that  you  have  designed  does  not  deliver  the   tax  benefits.     ¨  In  addiGon,  there  may  be  a  trade  off  between   mismatching  debt  and  geZng  greater  tax  benefits.   Deductibility of cash flows Differences in tax rates Overlay tax Zero Coupons for tax purposes across different locales preferences If tax advantages are large enough, you might override results of previous step Aswath Damodaran 13 While  keeping  equity  research  analysts,  raGngs   agencies  and  regulators  applauding   14 ¨  RaGngs  agencies  want  companies  to  issue  equity,  since  it   makes  them  safer.     ¨  Equity  research  analysts  want  them  not  to  issue  equity   because  it  dilutes  earnings  per  share.     ¨  Regulatory  authoriGes  want  to  ensure  that  you  meet  their   requirements  in  terms  of  capital  raGos  (usually  book  value).     ¨  Financing  that  leaves  all  three  groups  happy  is  nirvana.   Consider Analyst Concerns Ratings Agency Regulatory Concerns Operating Leases ratings agency - Effect on EPS - Effect on Ratios - Measures used MIPs & analyst concerns - Value relative to comparables - Ratios relative to comparables Surplus Notes Can securities be designed that can make these different entities happy? Aswath Damodaran 14 Debt  or  Equity:  The  Strange  Case  of  Trust   Preferred   15 ¨  Trust  preferred  stock  has   ¤ A  fixed  dividend  payment,  specified  at  the  Gme  of  the  issue   ¤ That  is  tax  deducGble   ¤ And  failing  to  make  the  payment  can  give  these   shareholders  voGng  rights     ¨  When  trust  preferred  was  first  created,  raGngs   agencies  treated  it  as  equity.  As  they  have  become   more  savvy,  raGngs  agencies  have  started  giving   firms  only  parGal  equity  credit  for  trust  preferred.   Aswath Damodaran 15 Debt,  Equity  and  Quasi  Equity   16 ¨  Assuming  that  trust  preferred  stock  gets  treated  as   equity  by  raGngs  agencies,  which  of  the  following   firms  is  the  most  appropriate  firm  to  be  issuing  it?   a.  A  firm  that  is  under  levered,  but  has  a  raGng  constraint   that  would  be  violated  if  it  moved  to  its  opGmal   b.  A  firm  that  is  over  levered  that  is  unable  to  issue  debt   because  of  the  raGng  agency  concerns.   Aswath Damodaran 16 Soothe  bondholder  fears   17 ¨  There  are  some  firms  that  face  skepGcism  from   bondholders  when  they  go  out  to  raise  debt,   because   ¤ Of  their  past  history  of  defaults  or  other  acGons   ¤ They  are  small  firms  without  any  borrowing  history   ¨  Bondholders  tend  to  demand  much  higher  interest   rates  from  these  firms  to  reflect  these  concerns.   Observability of Cash Flows Type of Assets financed Existing Debt covenants Convertibiles by Lenders - Tangible and liquid assets Factor in agency - Restrictions on Financing Puttable Bonds - Less observable cash flows create less agency problems conflicts between stock Rating Sensitive lead to more conflicts and bond holders Notes LYONs If agency problems are substantial, consider issuing convertible bonds Aswath Damodaran 17 And  do  not  lock  in  market  mistakes  that  work   against  you   18 ¨  RaGngs  agencies  can  someGmes  under  rate  a  firm,  and   markets  can  under  price  a  firm’s  stock  or  bonds.  If  this   occurs,  firms  should  not  lock  in  these  mistakes  by  issuing   securiGes  for  the  long  term.  In  parGcular,     ¤  Issuing  equity  or  equity  based  products  (including  converGbles),   when  equity  is  under  priced  transfers  wealth  from  exisGng   stockholders  to  the  new  stockholders   ¤  Issuing  long  term  debt  when  a  firm  is  under  rated  locks  in  rates   at  levels  that  are  far  too  high,  given  the  firm’s  default  risk.   ¨  What  is  the  soluGon   ¤  If  you  need  to  use  equity?   ¤  If  you  need  to  use  debt?   Aswath Damodaran 18 Designing  Debt:  Bringing  it  all  together   19 Start with the Cyclicality & Growth Patterns Cash Flows Other Effects Duration Currency Effect of Inflation on Assets/ Uncertainty about Future Projects Fixed vs. Floating Rate Straight versus Special Features Commodity Bonds More floating rate Convertible on Debt Catastrophe Notes Duration/ Currency - if CF move with - Convertible if - Options to make Define Debt Maturity Mix inflation cash flows low cash flows on debt Characteristics - with greater uncertainty now but high match cash flows on future exp. growth on assets Design debt to have cash flows that match up to cash flows on the assets financed Deductibility of cash flows Differences in tax rates Overlay tax Zero Coupons for tax purposes across different locales preferences If tax advantages are large enough, you might override results of previous step Analyst Concerns Ratings Agency Regulatory Concerns Consider Operating Leases ratings agency - Effect on EPS - Effect on Ratios - Measures used MIPs & analyst concerns - Value relative to comparables - Ratios relative to comparables Surplus Notes Can securities be designed that can make these different entities happy? Observability of Cash Flows Type of Assets financed Existing Debt covenants Convertibiles by Lenders - Tangible and liquid assets Factor in agency - Restrictions on Financing Puttable Bonds - Less observable cash flows create less agency problems conflicts between stock Rating Sensitive lead to more conflicts and bond holders Notes LYONs If agency problems are substantial, consider issuing convertible bonds Uncertainty about Future Cashflows Credibility & Quality of the Firm Consider Information Aswath Damodaran Asymmetries - When there is more uncertainty, it - Firms with credibility problems may be better to use short term debt will issue more short term debt 19 Approaches  for  evaluaGng  Asset  Cash  Flows   20 I.  IntuiGve  Approach   ¤  Are  the  projects  typically  long  term  or  short  term?  What  is  the  cash   flow  paUern  on  projects?     ¤  How  much  growth  potenGal  does  the  firm  have  relaGve  to  current   projects?   ¤  How  cyclical  are  the  cash  flows?  What  specific  factors  determine  the   cash  flows  on  projects?   II.  Project  Cash  Flow  Approach   ¤  EsGmate  expected  cash  flows  on  a  typical  project  for  the  firm   ¤  Do  scenario  analyses  on  these  cash  flows,  based  upon  different  macro   economic  scenarios   III.  Historical  Data   ¤  OperaGng  Cash  Flows   ¤  Firm  Value   Aswath Damodaran 20

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