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  • Like equity, debt also has market value which may be different from its book value. Market value of debt depends upon the current interest rate applicable for the similar kind of debt in the market. In other words, difference between market value and book value of the debt is dependent upon the difference between book interest and current interest rate applicable on debt. If the current interest rate applicable for the firm is same as book interest rate which its paying, there will be no difference in the book value and market value of debt. Basically market value of the debt adjust itself to reflect any change in the current interest rate applicable for the firm. This how bond market functions. We can see change in the market price of bonds due to change in current interest rate applicable for the firm. There is inverse relationship between bond prices and bond yield (i.e. return from bond). Lest understand this with the help of an example:

    Example:

    Bond Issue Price (Book Value): 100,

    Coupon rate: 5%,

    Current applicable Interest rate for this bond: 8%

    Issue date: 1 January 2011

    Redemption date: 31 Dec 2020

    Today: 1 January 2016

    Find market value of debt (as on 1 Jan 2016)

    As discussed above, market value of debt should reflect the current applicable interest rate for similar kind of bonds. In other words market value would be the price at which return to the purchaser would be equal to current interest rate applicable for the bond. The easiest way to find this market value is by discounting future interest payment and redemption value by current applicable interest rate (as shown below):

    Market value of bond = PV of future Interest payments + PV of redemption value

     

    Market Value of Debt =

    n=1

    Σ            ( Book Interest n /(1+r)^n)  +  (Redemption Value / (1+r)^5)

    n=5

     

    Market value of Debts = (5/(1+8%)^1) +  (5/(1+8%)^2)+ (5/(1+8%)^3)+ (5/(1+8%)^4)+ (5/(1+8%)^5)+ (100/(1+8%)^5)

     

    Market value of debts = 20 +68 =88

     

    However in case of a real company, the process of finding market value of debt may be bit tedious due to number of debts the company is having in its balance sheet with different maturity periods and interest rates. In that case instead of finding market value of individual debt, we can find market value of all debts together by finding weighted average maturity life and interest rate. Lets do this exercise for a real company named Tesco PLC.

    Step 1: Find the detailed breakup of debt in the latest filing of the company

    Step 2: Calculate the weighted average maturity period of all the different debt outstanding

    Step 3: Calculate weighted average book interest rate for all debts outstanding

    Step 4: Calculate current cost of debt for the company

    Step 5: Calculate the present value of book interest payment to be made by discounting them with current cost of debt calculated in step 4

    Step 6: Calculate present value of redemption value of debt by discounting it with current cost of debt calculated in step 4

    Step 7: Market value of debt  = Value calculated in step 5 + Value calculated in step 6

  • Rizwan Khan

    How can we can project cost as a percentage of sales median of previous years used for future if we are doing this we are neglicting effect of operating leverage. ??