DEBT DESIGN Aswath Damodaran The key idea Debt

DEBT DESIGN Aswath Damodaran

The key idea Debt that behaves like equity If you can tie the cash flows on your debt closely to the cash flows from operations (on your assets), you can borrow more money at lower rates. That will lower your cost of debt and cost of capital. 2

Intuitive Debt Design Start with the typical project for your firm. If it is multiple businesses, each business may have a different project type. Think about a security that will meet the debt test (finite maturity, contractual payments, consequences from failure to pay) with the payments tied to the typical project’s cash flows. 3

Let’s try Walmart Typical project A new store, with a life of perhaps 12 -15 years. Cash flows are in whatever currency applies for the location of the store Mildly cyclical (because it is a discount retailer) Very little pricing power Mature company The perfect debt Long term (12 -15 years) Currency matched to where Walmart is opening its stores Fixed rate (payments) No conversion options or equity tweaks 4

To try to get more specific answers, you can look at your company’s history To do this assessment, your company needs to have a long history. Start with the following data: Market capitalization at the end of each year Total Debt outstanding at the end of each year (You would like this to include PV of leases each year but that may be asking too much) Operating income each year. Suggestion: Use the Bloomberg terminal to good effect. If you find your company, type FA and the pick the Enterprise value tab, you should get all of this data for as many years as you want. Aside: Your life will be a lot easier if you have a calendar year end. 5

And look at the relationship with macro variables You could look at macro or external drivers of your company’s value. For instance, here are four standard macro variables: Long term interest rates Real Economic growth Inflation Currency Getting this data for the US is easy. (FRED) It should be available for other countries, but it may require more work. You can also add other macro variables that may impact your company (Defense budget for a defense contractor, Oil prices for an oil company etc. ) 6