Cost of Debt 12 1 13 This assumes the riskfree rate has no country risk premium

Cost of debt 12 1 13 this assumes the riskfree rate

This preview shows page 57 - 60 out of 60 pages.

Cost of Debt = 12% + 1% = 13% (This assumes the riskfree rate has no country risk premium embedded in it.)Approach 2: Use the differential inflation rate to estimate the cost of capital. For instance, if the inflation rate in BR is 8% and the inflation rate in the U.S. is 2%Cost of capital== 0.1644 or 16.44%
Background image
Aswath Damodaran58Dealing with Hybrids and Preferred StockWhen dealing with hybrids (convertible bonds, for instance), break the security down into debt and equity and allocate the amounts accordingly. Thus, if a firm has $ 125 million in convertible debt outstanding, break the $125 million into straight debt and conversion option components. The conversion option is equity.When dealing with preferred stock, it is better to keep it as a separate component. The cost of preferred stock is the preferred dividend yield. (As a rule of thumb, if the preferred stock is less than 5% of the outstanding market value of the firm, lumping it in with debt will make no significant impact on your valuation).
Background image
Aswath Damodaran59Decomposing a convertible bond…Assume that the firm that you are analyzing has $125 million in face value of convertible debt with a stated interest rate of 4%, a 10 year maturity and a market value of $140 million. If the firm has a bond rating of A and the interest rate on A-rated straight bond is 8%, you can break down the value of the convertible bond into straight debt and equity portions.Straight debt = (4% of $125 million) (PV of annuity, 10 years, 8%) + 125 million/1.0810= $91.45 million Equity portion = $140 million - $91.45 million = $48.55 million
Background image
Aswath Damodaran60Recapping the Cost of Capital
Background image

You've reached the end of your free preview.

Want to read all 60 pages?

  • Spring '11
  • tnaga
  • Interest, Risk premium, equity risk premium

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture