This question isn’t specifically related to the CFA exam, however I figured this would be the most appropriate place to ask. When coming up with the cost of debt for calculating WACC I’m trying to figure out what would be the best way. My first instinct is to use yield to maturity on outstanding bonds rather than a spread based on rating, as it shows what an investor would need to get paid to take on the companies debt, and is the most accurate portrayal of what additional debt would cost. However depending on the structure of the bonds outstanding, the yields vary from 0.60% all the way 9.50% for the different structures. So for all you ERs, what do you typically do in this situation. Weighted average yield based on amounts o/s? One specific yield? The yield on the closest bond to your risk free rate maturity in CAPM? Industry standard? Or simply rating spread? (If rating spread any good sites that lay out spread tables?) I’m trying to figure what the most “official” way of doing it is. (i.e., what do they use in real ER roles). Just trying to work on detailed, legitimate modeling and getting better.
umm although i couldnt fully understand what u wanted to say but my view is: 1) cost of capital is defined as the minimum amount(as a %) a company needs to earn to maintain its market value and is often based on the long run financial structure… therefore,the appropriate rate should be the post tax YTM on similarly rated bonds in the market
Note: I’m not in equity research, per se, but I do calculate and use WACC daily. These calculations are used in expert witness testimony and exhibits to said testimony, so I would say they are the correct way of doing so. When calculating the cost of debt, I use the weighted average yield. I don’t know how big of a credit spread matrix you need, but credittrends.moodys.com publishes a small spread matrix for investment grade bonds daily. I think you have to sign up, but its free. Hope that helps.
Use the lower available yield for debt as long as that yield is available to te company.
Its not intuitive for a company to issue debt at a higher yield.
That said, if there are several types of debt in the debt structure, perhaps the company cannot issue at the lower yield anymore. You should always use the lower rate at which the company can issue debt today.
yup. good job.
stated another way…market previaling rates
i guess my question really comes down to what maturity. im understand that using the prevailing yield on their debt is the most accurate cost for the company to issue debt,. it just doesnt seem right to use the 1.2% to maturity in '14 and it doesn’t seem right to use the debt yielding 6% with a '27 maturity.
if the company can issue with shorter maturity, thus lower yield, use this one. use the lower yield the company is able to issue at.
if it is for a specific project and yo know which type of debt you would issue for that particular project, its a different story