The current value of debt
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The Market Value of Debt refers to the market price investors would be willing to buy a company’s debt for, which differs from the book value on the balance sheet. A company’s debt doesn’t always come in the form of publicly traded bonds, which have a specified market value. Instead, many companies own debt that can be classified as non-traded, such as bank loans.
Because this debt is reported at book value or accounting value in the financial statements, it is the analysts’ responsibility to calculate the market value, which will be of major importance when calculating the company’s total Enterprise Value.
Formula for Market Value of Debt
To estimate the Market Value of Debt, an analyst can think of the Total Debt on the books as a single coupon bond, with the coupon being equal to the interest expenses on all debt and the maturity as the weighted average maturity of the debt.
The bond pricing formula to calculate the market value of debt is:
C[(1 – (1/((1 + Kd)^t)))/Kd] + [FV/((1 + Kd)^t)]
Where C is the interest expense (in dollars)
Kd is the current cost of Debt (in percentages)
T is the weighted average maturity (in years)
FV represents the total debt
Example Calculation
C[(1 – (1/((1 + Kd)^t)))/Kd] + [FV/((1 + Kd)^t)]
Where C is the interest expense = $25,000
Kd is the current cost of Debt = (.038) 3.8%
t is the weighted average maturity = 8.94 years
FV represents the total debt = $540,000
Substituting:
25,000[(1 – (1/((1 + .038)^8.94)))/.038] + [540,000/((1 + .038)^8.94)] = $573,427.15
Therefore, our calculated MV of Debt is $573,441.15, which can be later used to calculate the Enterprise Value by adding the Cash and Cash Equivalents to our calculated MV of Debt. This value can then be compared with the market cap and used for the calculation of financial ratios to complete the analyst’s toolbox.
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Factors Influencing Market Value of Debt
The market value of debt and other fixed-income securities is influenced by many factors. It’s important to have a solid understanding of what these factors are and what impact they have on the value of debt, directionally speaking.
Factors influencing the market value of debt:
- Interest rates – the market price of debt has an inverse relationship to interest rates (as rates go up, prices go down)
- Company performance – the more ability a company has to service its debt (generating more cash flow), the higher the value of its debt will be
- Value of assets – if the value of the assets that are used as collateral on the debt significantly declines, the market value of debt is likely to decline, too
- Covenants – lenders setcovenants the borrowing company must meet, and if they are breached, then the value of debt would be negatively impacted
When evaluating the market price of debt, it’s important to take all of the above factors into consideration.
Related Reading
Thank you for reading CFI’s guide to Market Value of Debt. To continue learning and advancing your career as a financial analyst, these additional CFI resources will be helpful:
