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Objective

Beforeyoustart
Inputs
Units
Incomeinputs

BalanceSheet
MarketData

TaxRate
DefaultSpreads

Summary
Details

PRELIMINARYSTUFFANDINPUTS
Thisspreadsheetallowsyoutocomputetheoptimalcapitalstructureforanonfinancial
servicefirm.Ifyouhaveafinancialservicefirmusecapstrfin.xls
Openpreferencesinexcel,gointocalculationoptionsandputacheckintheiterationbox.
Ifitisalreadychecked,leaveitasis.
Theinputsareprimarilyintheinputsheet.Ifyourcompanyhasoperatingleases,
usetheoperatingleaseworksheettoenteryourleaseorrentalcommitments.
Enterallnumbersinthesameunits(000s,millionsorevenbillions)
ThekeyincomeinputsareEBITDA,depreciationandamortizationandinterestexpenses.
Enterthemostupdatednumbersyouhaveforeach(eveniftheyare12monthtrailing
numbers).Ifthemostrecentperiodforwhichyouhavedatahasanoperatingincomethat
isabnormal,eitherbecauseofextraordinarylosses/gainsorsomeotheroccurrence,use
anaverageoperatingincomeoverthelastfewyears.
Fromthestatementofcashflows,alsoenterthecapitalspendingfromtherecentperiod.
P.S:Ifyouhavenegativeoperatingincomeandyouexpecttocontinuehavingnegative
operatingincome,youroptimaldebtratiowillbezero.
Enterthebookvalueofallinterestbearingdebt.Ifyouhaveamarketvalueenterthat
number.Alternatively,inputtheaveragematurityofthedebtandIwillestimatethe
marketvalueofdebt.
Enterthecurrentstockprice,thecurrentlongtermgovernmentbondrate,therisk
premiumyouwouldliketousetoestimateyourcostofequityandthecurrentratingfor
yourfirm.Ifyoudonothavearating,thereisanoptionforyouattheverybottomof
thespreadsheettocomputeasyntheticrating.
Enteramarginaltaxrate,ifyoucanestimateit.Otherwise,usetheeffectivetaxrate.
Thisspreadsheethasinterestcoverageratios,ratingsanddefaultspreadsbuiltintoitin
theworksheet.Thisspreadsheettreatstheimputedinterestexpenseonoperatingleasesaspartofthe
interestexpensewhencomputingtheinterestcoverageratio.Youcanchoosebetweenratingsforlargefirms
(firmswithmarketcapitalizationsthatexceed$5billionisasimplecutoffbutyoucandeviatefromit)
amoreconservatveforsmallorriskyfirms.Ifyouwant,youcanchangetheinterest
coverageratiosandratingsinthesetables.
READINGTHEOUTPUT
Thesummaryprovidesapictureofyourfirm'scurrentcostofcapitalanddebtratio,and
comparesittoyourfirm'svalueateverydebtraito,incorporatingthetaxbenefitsfromdebt&theexpected
bankruptcycostsateachlevelofdebt.
Thedetailsofthecalculationateachdebtratioarebelowthesummary.

References
CorporateFinance:TheoryandPractice,Chapter18
AppliedCorporateFinance:Chapter8

saspartofthe
ratingsforlargefirms
andeviatefromit)

mdebt&theexpected

Question
Q1:WhatdoIdoexcelsaystherearecircularreferen
Q2:Myspreadsheethasgonecrazy.Igeterrorsallov
WhatdidIdowrong?
Q3:Iamenteringtheinputsformycompanybutthe
optimalnumbersdonotseemtochangefromthe
originals
Q4:Iamgettinganoptimaldebtratioof0%.Thiscan
beright.Canit?

Answer
Gointopreferences,choosecalculationoptionsandmakesuretheiterationboxhasacheckinit.
Iamsorrytosaythis,butyouprobablyjustmadeaninputerror.Whileyoumighthave
fixedit,theiterationsinthespreadsheetmakeitverysensitiveandtheerrorswillnot
goaway.Theonlyfix(Sorry,sorry)istocopytheinputsintoafreshversionofthespreadsheet.
Youprobablyforgottochecktheiterationbox(seeQ1)
Sure.Ifyouroperatingincomeiseithernegativeorverylow,relativetoyourfirmvalue,
youcanendupatanoptimaldebtratioof0%.Forinstance,ifyouhaveEBITof100ona
firmvalueof10000,a10%debtratiowouldprobablypushyouintoaCratingandgive
youaveryhighcostofcapital.

Inputs
Pleaseenterthenameofthecompanyyouareanalyzing:
Dateofanalysis

Hormel
22Apr13

FinancialInformation
Earningsbeforeinterest,taxesanddepreciation(EBITDA)

$635.00

DepreciationandAmortization:

$126.00

CapitalSpending:

$126.00

Interestexpenseondebt:

$28.00

Taxrateonordinaryincome:

40.00%

CostofBankrtupcyasapercentofmarketvalueoffirm=

25.00%

CurrentRatingondebt(ifavailable):
Interestratebaseduponrating:

Aaa/AAA
2.75%

MarketInformation
Numberofsharesoutstanding:

134.526

Marketpricepershare:

$31.08

Betaofthestock:
Bookvalueofdebt:
Canyouestimatethemarketvalueoftheoutstandingdebt?

0.83
$450.00
No

Ifso,enterthemarketvalueofdebt:
Doyouwantmetotryandestimatemarketvalueofdebt?

Yes

Ifyes,entertheaveragematurityofoutstandingdebt?

0.00

Doyouhaveanyoperatingleases?

Yes

GeneralMarketData
Currentlongterm(LT)governmentbondrate:

2.35%

Riskpremium(foruseintheCAPM)

6.00%

Countrydefaultspread(forcostofdebt)

0.00%

GeneralData
Whichspread/ratiotablewouldyouliketouseforyouranlaysis?

Doyouwanttoassumethatexistingdebtisrefinancedatthe'new'rate?

Yes

Doyouwantthefirm'scurrentratingtobeadjustedtothesyntheticrating?

Yes

(inpercent)
(inpercent)

(YesorNo)
(YesorNo)

OperatingLeaseConverter

Operatingleaseexpensesarereallyfinancialexpenses,andshouldbetreatedassuch.Accountingstandardsallowth
betreatedasoperatingexpenses.Thisprogramwillconvertcommitmentstomakeoperatingleasesintodebtand
adjusttheoperatingincomeaccordingly,byaddingbacktheimputedinterestexpenseonthisdebt.
Inputs
Operatingleaseexpenseincurrentyear=
OperatingLeaseCommitments(Fromfootnotetofinancials)
Year
Commitment !Year1isnextyear,.
1
$10.00
2
$8.07
3
$6.76
4
$5.21
5
$4.51
6andbeyond $11.94
PretaxCostofDebt=

2.75%

$21.90

!Ifyoudonothaveacostofdebt,usetheattachedratingsestimator

Fromthecurrentfinancialstatements,enterthefollowing
ReportedOperatingIncome(EBIT)=
$509.00 !ThisistheEBITreportedinthecurrentincomestatement
ReportedInterestExpenses=
$28.00
Output
Numberofyearsembeddedinyr6estimate=
1
!Iusetheaverageleaseexpenseoverthefirstfiveyears
toestimatethenumberofyearsofexpensesinyr6
ConvertingOperatingLeasesintodebt
Year
Commitment
PresentValue
1 $10.00
$9.73
2 $8.07
$7.64
3 $6.76
$6.23
4 $5.21
$4.67
5 $4.51
$3.94
6andbeyond
$11.94
$10.15 !Commitmentbeyondyear6convertedintoanannuityfortenyears
DebtValueofleases=
$42.37
RestatedFinancials
OperatingIncomewithOperatingleasesreclassifiedasdebt=
InterestexpenseswithOperatingleasesclassifiedasdebt=

$530.90
$29.17

verter

ountingstandardsallowthemto
ngleasesintodebtand

entincomestatement

thefirstfiveyears

Inputsforsyntheticratingestimation

Enterthetypeoffirm=
2 (Enter1iflargemanufacturingfirm,2ifsmallerorriskierfirm,3iffinancialservicefi
EntercurrentEarningsbeforeinterestandtaxes(EBIT)=
$530.90
Entercurrentinterestexpenses=
$29.17
Entercurrentlongtermgovernmentbondrate=
2.35%
Output
18.20
Interestcoverageratio=
EstimatedBondRating=
Aaa/AAA
EstimatedDefaultSpread=
0.40%
2.75%
EstimatedCostofDebt=
Forlargeorstablefirms
Ifinterestcoverageratiois
>
to
100000
0.199999
0.2
0.649999
0.65
0.799999
0.8
1.249999
1.25
1.499999
1.5
1.749999
1.75
1.999999
2
2.2499999
2.25
2.49999
2.5
2.999999
3
4.249999
4.25
5.499999
5.5
6.499999
6.5
8.499999
8.50
100000

Ratingis
D2/D
C2/C
Ca2/CC
Caa/CCC
B3/BBa1/BB+
Ba2/BB
B1/B+
B2/B
Baa2/BBB
A3/AA2/A
A1/A+
Aa2/AA
Aaa/AAA

Spreadis
12.00%
10.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.25%
2.75%
1.75%
1.20%
1.00%
0.90%
0.70%
0.40%

BankruptcyProbability
100%
85%
70.00%
59.01%
45.00%
36.80%
25.00%
16.63%
10.00%
7.54%
2.50%
0.66%
0.60%
0.51%
0.07%

Forsmallerandriskierfirms
Ifinterestcoverageratiois
greaterthan
to
100000
0.499999
0.5
0.799999
0.8
1.249999
1.25
1.499999
1.5
1.999999
2
2.499999
2.5
2.999999
3
3.499999
3.5
3.9999999
4
4.499999
4.5
5.999999
6
7.499999
7.5
9.499999

Ratingis
D2/D
C2/C
Ca2/CC
Caa/CCC
B3/BBa1/BB+
Ba2/BB
B1/B+
B2/B
Baa2/BBB
A3/AA2/A
A1/A+

Spreadis
12.00%
10.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.25%
2.75%
1.75%
1.20%
1.00%
0.90%

BankruptcyProbability
100%
85%
70.00%
59.01%
45.00%
36.80%
25.00%
16.63%
10.00%
7.54%
2.50%
0.66%
0.60%

9.5
12.5

12.499999
100000

Aa2/AA
Aaa/AAA

0.70%
0.40%

0.51%
0.07%

allerorriskierfirm,3iffinancialservicefirm)
(Addbackonlylongterminterestexpenseforfinancialfirms)
(Useonlylongterminterestexpenseforfinancialfirms)

C2/C

CAPITALSTRUCTURE

17

Hormel
22Apr13
CapitalStructure
CurrentMVofEquity=
MarketValueofinterestbearing
#ofSharesOutstanding=
DebtValueofOperatingleases(
RiskPremium=

$4,181
$450
134.526
$42
6.00%

FinancialMarket
CurrentBetaforStock=
CurrentBondRating=
SummaryofInputs
LongTermGovernmentBondRate=
Pretaxcostofdebt=

0.83
Aaa/AAA

Maximumfirmvalu
Optimaldebtratio

2.35%
2.75%

IncomeStatement
CurrentEBITDA=
CurrentDepreciation=
CurrentTaxRate=
CurrentCapitalSpending=
CurrentInterestExpense=

$5,403
50.00%

AdjustedPresentValueEstimates

DebtRatio
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%

$Debt
$0
$467
$935
$1,402
$1,869
$2,337
$2,804
$3,271
$3,739
$4,206

UnleveredfirmvalueTaxBenefitsfromDebtExpectedBankruptcyCost
$4,477
$0
$1
$4,477
$187
$1
$4,477
$374
$1
$4,477
$561
$6
$4,477
$748
$8
$4,477
$935
$9
$4,477
$1,122
$350
$4,477
$1,309
$651
$4,477
$1,495
$672
$4,477
$1,682
$1,078

Weusethefollowingdefaultspreadsinouranalysis.Changethemintheinputsheetifnecessary:
Rating
Coveragegt
andlt
Spread
AAA
12.5
100000
AA
9.5
12.499999
A+
7.5
9.499999
A
6
7.499999
A
4.5
5.999999
BBB
4
4.499999
BB
3
3.499999
B+
2.5
2.999999
B
2
2.499999
B
1.5
1.999999
CCC
1.25
1.499999
CC
0.8
1.249999
C
0.5
0.799999
D
100000
0.499999

0.40%
0.70%
0.90%
1.00%
1.20%
1.75%
3.25%
4.00%
5.00%
6.00%
7.00%
8.00%
10.00%
12.00%

DefaultProbability
0.07%
0.51%
0.60%
0.66%
2.50%
7.54%
16.63%
25.00%
36.80%
45.00%
59.01%
70.00%
85.00%
100.00%

LeveredFirmValue
$4,477
$4,663
$4,850
$5,032
$5,217
$5,403
$5,249
$5,135
$5,301
$5,082

Ratingscomparisonatcurrentdeb
CurrentInterestcoverageratio=
Ratingbaseduponcoverage=
Interestratebaseduponcoverage=
Currentratingforcompany=
Currentinterestrateondebt=
CurrentBankruptcyProbability=

CAPITALSTRUCTURE

18

Currentbe
CurrentD
Taxrate=

0.83
$492
40.00%

$4,181
$657
Aaa/AAA

D/(D+E)
D/E
$Debt
Beta
CostofEqu

0.00%
0.00%
$0
0.78
7.00%

10.00%
11.11%
$467
0.83
7.31%

20.00%
25.00%
$935
0.89
7.70%

EBITDA
Depreciati
EBIT
Interest
TaxableIn
Tax
NetIncom
(+)Deprec'
Fundsfrom

$657
$126
$531
$0
$531
$212
$319
$126
$445

$657
$126
$531
$13
$518
$207
$311
$126
$437

$657
$126
$531
$26
$505
$202
$303
$126
$429

$657
$126
$531
$43
$488
$195
$293
$126
$419

$657
$126
$531
$61
$470
$188
$282
$126
$408

$657
$126
$531
$78
$453
$181
$272
$126
$398

$657
$126
$531
$178
$353
$141
$212
$126
$338

PretaxInt
Funds/Debt
LikelyRat
Pretaxcos
Probability
Eff.TaxRa

AAA
2.75%
0.07%
40.00%

41.31
0.93
Aaa/AAA
2.75%
0.07%
40.00%

20.65
0.46
Aaa/AAA
2.75%
0.07%
40.00%

12.42
0.30
Aa2/AA
3.05%
0.51%
40.00%

8.74
0.22
A1/A+
3.25%
0.60%
40.00%

6.78
0.17
A2/A
3.35%
0.66%
40.00%

2.98
0.12
Ba2/BB
6.35%
25.00%
40.00%

Interestcov
Low
100000
0.5
0.8
1.25
1.5

Interestcov
High
0.499999
0.799999
1.249999
1.499999
1.999999

RATING

Interestrate

D2/D
C2/C
Ca2/CC
Caa/CCC
B3/B

14.35%
12.35%
10.35%
9.35%
8.35%

CurrentEquity=
CurrentEBITDA=
CurrentRating=

CurrentDepreciation=
CurrentInterestrate(Company)=
CurrentT.Bondrate=

WORKSHEETFORESTIMATINGRATINGS/INTERESTRATES
30.00%
40.00%
50.00%
42.86%
66.67%
100.00%
$1,402
$1,869
$2,337
0.97
1.09
1.24
8.20%
8.86%
9.79%

60.00%
150.00%
$2,804
1.47
11.19%

Bankruptcy
Probability
100.00%
85.00%
70.00%
59.01%
45.00%

CAPITALSTRUCTURE
2
2.5
3
3.5
4
4.5
6
7.5
9.5
12.5

2.499999
2.999999
3.499999
3.9999999
4.499999
5.999999
7.499999
9.499999
12.499999
100000

19

Ba1/BB+
Ba2/BB
B1/B+
B2/B
Baa2/BBB
A3/A
A2/A
A1/A+
Aa2/AA
Aaa/AAA

7.35%
6.35%
5.60%
5.10%
4.10%
3.55%
3.35%
3.25%
3.05%
2.75%

36.80%
25.00%
16.63%
10.00%
7.54%
2.50%
0.66%
0.60%
0.51%
0.07%

AdjustedPresentValueApproach
CurrentValueoftheFirm=

$4,673

TaxBenefitonCurrentDebt=
+ExpectedCurrentBankruptcyCost=
UnleveredValueofFirm=

DebtRatio

$197

CostofBankruptcy(%ofValue)=

$1

CurrentProbabilityofBankrupcy=

$4,477

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

$0

$467

$935

$1,402

$1,869

$2,337

$2,804

Unlev.Fir

$4,477

$4,477

$4,477

$4,477

$4,477

$4,477

$4,477

TaxBenefi

$0

$187

$374

$561

$748

$935

$1,122

BondRatin

AAA

Aaa/AAA

Aaa/AAA

Aa2/AA

A1/A+

A2/A

Ba2/BB

Prob.ofDe

0.07%

0.07%

0.07%

0.51%

0.60%

0.66%

25.00%

Bankruptcy

$1

$1

$1

$6

$8

$9

$350

Indexvaria

LeveredFi

$4,477

$4,663

$4,850

$5,032

$5,217

$5,403

$5,249

DebtRatio
0%
10%
20%

$Debt
$0
$467
$935

TaxRate
40.00%
40.00%
40.00%

$Debt

UnleveredFirmValue
TaxBenefits
BondRating
$4,477
$0 AAA
$4,477
$187 Aaa/AAA
$4,477
$374 Aaa/AAA

ProbabilityofDefault
ExpectedBankruptcyCos
0.07%
$1
0.07%
$1
0.07%
$1

CAPITALSTRUCTURE
30%
40%
50%
60%
70%
80%
90%

$1,402
$1,869
$2,337
$2,804
$3,271
$3,739
$4,206

40.00%
40.00%
40.00%
40.00%
40.00%
40.00%
40.00%

$4,477
$4,477
$4,477
$4,477
$4,477
$4,477
$4,477

$561
$748
$935
$1,122
$1,309
$1,495
$1,682

Aa2/AA
A1/A+
A2/A
Ba2/BB
B3/B
B3/B
Ca2/CC

20
0.51%
0.60%
0.66%
25.00%
45.00%
45.00%
70.00%

$6
$8
$9
$350
$651
$672
$1,078

CAPITALSTRUCTURE

$657
$126
40.00%
$126
$29

Ratingscomparisonatcurrentdebtratio
terestcoverageratio=
eduponcoverage=
ebaseduponcoverage=
tingforcompany=
terestrateondebt=
ankruptcyProbability=

18.20
Aaa/AAA
2.75%
Aaa/AAA
2.75%
0.07%

21

CAPITALSTRUCTURE
$126
2.75%
2.35%

strate(Company)=

70.00%
233.33%
$3,271
1.86
13.51%

80.00%
400.00%
$3,739
2.64
18.16%

90.00%
900.00%
$4,206
4.96
32.12%

$657
$126
$531
$273
$258
$103
$155
$126
$281

$657
$126
$531
$312
$219
$87
$131
$126
$257

$657
$126
$531
$435
$96
$38
$57
$126
$183

1.94
0.09
B3/B
8.35%
45.00%
40.00%

1.70
0.07
B3/B
8.35%
45.00%
40.00%

1.22
0.04
Ca2/CC
10.35%
70.00%
40.00%

22

CAPITALSTRUCTURE

25%
0.07%

70.00%

80.00%

90.00%

$3,271

$3,739

$4,206

$4,477

$4,477

$4,477

$1,309

$1,495

$1,682

B3/B

B3/B

Ca2/CC

45.00%

45.00%

70.00%

$651

$672

$1,078

$5,135

$5,301

$5,082

ValueofLeveredFirm
$4,477
$4,663
$4,850

23

CAPITALSTRUCTURE
$5,032
$5,217
$5,403
$5,249
$5,135
$5,301
$5,082

24

Rating is
Aaa/AAA
Aa2/AA
A1/A+
A2/A
A3/ABaa2/BBB
Ba1/BB+
Ba2/BB
B1/B+
B2/B
B3/BCaa/CCC
Ca2/CC
C2/C
D2/D

Yes/No
Yes
No

IBC
High
Medium
Low

Type of firm
1
2