06 Apr Market Value of Debt
What is Market Value of Debt?
Definition: The market value of debt is the amount that an investor would be willing to pay for a company’s debt. This sum could be different from the value reflected in the books.
What does Market Value of Debt mean?
A part of a company’s debt may be comprised of bonds that are traded in the market. The market value of these bonds can easily be found on the publicly listed bond markets.
However, how will you value the debt that is not traded in the bond market? Companies often borrow from banks. The value of this debt is reflected at book value and not at market value.
The technique to arrive at market value of debt is as follows:
- Determine the amount of debt that is not traded in the market. As mentioned above, this could include bank debt.
- Next, calculate the total amount that is paid as interest on this debt on a yearly basis.
- Now, calculate the face-value weighted average maturity for this debt. You will have to do this as there could be several bank loans, each of which has a different maturity date.
- As a result of steps 1, 2, and 3, you now have a hypothetical coupon bond with a certain maturity and coupon rate.
- The next step is to determine the current cost of debt.
- You can now calculate the market value of debt by using this formula:
Market value of debt = C[(1-(1/((1+Kd)^t)))/Kd] + [FV/((1+Kd)^t)]
C = interest expense on the total debt
Kd = current cost of debt
t = weighted average maturity period
FV = total debt
Example of Market Value of Debt
Holbroke Corporation’s has a total bank debt of $1 million. We can calculate the market value of this debt in the following manner.
The relevant data for Holbroke is:
Total debt = $1 million (FV)
Current interest expense = $100,000 (C)
Current cost of debt = (.05) 5% (Kd)
Weighted average maturity = 6 years (t)
The formula for market value of debt is C[(1-(1/((1+Kd)^t)))/Kd] + [FV/((1+Kd)^t)]
By carrying out the calculation for Holbroke Corp. we arrive at $1,253,784 as the market value of its debt.
Remember that the market value of debt has an inverse relationship with interest rates. If the interest rates that are prevalent in the market when the calculation is being done are higher than the interest rate that the company is paying, the market value of its debt will be lower than that which is reflected in its books. The reverse will be true if current interest rates are lower than the company’s interest rate.
The current interest rate isn’t the only factor that influences the market value of debt. The company’s performance and its ability to service its debt obligations also play a role. If a company has provided some of its assets as collateral for the debt, the value of these assets will also have an impact on the market value of debt.
The calculation of market value of debt has to be done very carefully after taking all these factors into consideration.