Session 11: Costs of Debt & Capital

Aswath Damodaran
Aswath Damodaran
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Published 2023-03-08
Intros class, we started by looking at estimating a cost of debt, specifying that it is the cost of borrowing money long term, today. Finally, w explained our preferences for market value weights on debt and equity in a cost of capital calculation, arguing that market value weights trump book value weights every single time. For the market value of debt, we argued for including both interest bearing debt converted to market value and the present value of lease commitments. To get a cost of debt, you need a bond rating (actual or synthetic) as well as default spreads that go with these ratings. The former should be available for your company, if it is rated. If not, use the following spreadsheet to rate your company:
www.stern.nyu.edu/~adamodar/pc/ratings.xls
It comes with a lease converter, if you want to use it. The default spreads used to be accessible online for free at bondsonline.com, but it seems to be defunct. You can get default spreads for key ratings classes (AAA, AA, A, BBB, BB, B and CCC & below) from the Federal Reserve website in St. Louis.
fred.stlouisfed.org/categories/32348?t=corporate%3…
Look for the effective yield and then subtract out the risk free rate from it. While you may have to extrapolate from these numbers for intermediate ratings, it is eminently doable. Alternatively, you can get updated spreads for every ratings class from a Bloomberg terminal by typing in FIW, and resetting a couple of inputs.
Slides: pages.stern.nyu.edu/~adamodar/podcasts/cfspr23/ses…
Post class test: pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/post…
Post class test solution: pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/post…
All Comments (4)
  • @chandrannatarajan6616
    Thank you Professor, for another wonderful and remarkable session. Stay blessed always.
  • @dumaoctavian8523
    Thank you for another amazing lecture! I have a question regarding the weights for cost of capital. Can i use market value of debt with the book value of equity? In the case of the company im analysing, there market value of debt is about 12% lower than book value, but the market capitalisation is about 2x lower than the book value of equity. While trying not to be subjective, the company seems to be undervalued, so using the mk capitalisation as the weight for equity seems off.