In a privately owned business, neither debt nor equity is traded. In most publicly traded firms,...
In a privately owned business, neither debt nor equity is traded. In most publicly traded firms, equity has a market value but a significant portion (or often all) of the debt is not publicly traded.
(a) How do you calculate market value of debt when all or even some of your firm's debt is bank debt and not publicly traded? How would you compute an updated cost of debt for an unrated company with bank debt?
(b) How do you calculate the market value of equity for a private entity?
Homework Answers
a]
If the debt is not publicly traded, the interest rate of the debt is taken to be the yield on the loan. The market value is calculated in the same was as bonds, i.e. by discounting the future cash flows of the debt. The present value of the future cash flows (interest and principal payment) is the market value of the debt.
For an unrated company with bank debt, the same method is used. The interest rate of the debt is the yield of the debt, and the present value of debt payments is the market value of the debt
b]
Market value of equity is calculated by discounting the future free cash flows at the appropriate discount rate.
The free cash flows to equity are estimated for a certain period, and they are discounted to find the present value. The discount rate to use the required return of equity.
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