What Is Market Value Of Debt?
Definition: Market Value of Debt refers to the price at which investors would be willing to buy a company’s debt. It also refers to the amount of debt that companies have, but not reported directly in the balance sheet hence must be calculated.
The debt, in this case, encompasses publicly traded bonds as well as non-traded debts such as bank loans. While such debts come with the book value or accounting value, investors looking to invest in a company may peg a different value to their worth. Therefore, analysts calculate the market value of debt, which consequently helps in the calculation of the total Enterprise Value.
In financial statements, firms report the book value of their debt. However, the calculation of the Market Value of debt provides an accurate representation of the true value of the debt, as it takes into consideration both cash and debt that a firm owns.
One of the simplest ways of estimating the market value of debt is assuming total debt as a coupon bond. The coupon will, in this case, be equal to the value of interest expenses on the total debt. The maturity, on the other hand, would be equal to the weighted maturity of the mortgage.
The market value of debt differs from book value on the fact that not all of a company’s debt is publicly traded. While bonds are publicly traded and easy to determine their actual value bank loans don’t trade in the markets, and their value tend to change from time to time due to the effects of inflation.
Market Value of Debt Formula Calculation
When it comes to calculating the market value of debt, it is important first to ascertain debt that is not traded in the market. Such debts include things like bank loans or used credit lines. The next step involves determining the total amount of debt that is paid in interest on a yearly basis.
The face value of the weighted average maturity of the debt is also taken into consideration by focusing on different debts with different maturity debts. Once the current cost of debt is ascertained, then the market value of debt can be ascertained.
The simplest formula for calculating the market value of debt is:
C [(1 – (1/ ((1 + KD) ^t)))/Kd] + [FV/ ((1 + Kd) ^t)]
Whereby:
C= Interest expense (in dollars)
kd = cost of debt in percentage
t= weighted average maturity in years
FV= the total debt
Market Value of Debt Example
Consider company XYZ with bank debt of $1 million. The market value of this debt would be
FV-$1 million
Interest Expense = $100,000
Current cost of debt = 5% (kd)
Weighted average maturity of 6 years (t)
Upon inserting the values in C [(1 – (1/ ((1 + KD) ^t)))/Kd] + [FV/ ((1 + Kd) ^t)] it become clear that the total market value of debt in this case is $1,253,784
Market Value of Debt Importance
One of the reasons why people insist on the calculation of the market value of debt is that its final figure helps in the calculation of the true cost of capital. Likewise, investors and analysts use the financial metric to estimate future projections more so for financing growth and funding.
Companies also rely on this financial metric to make informed financial decisions, especially when seeking financing. Likewise, analysts rely on the market value of debt to ascertain the net worth of a business as it takes into consideration all the debts that a company owes.
Summary
Market Value of debt provides an ideal way of valuing company or business by taking into consideration all debts that the business owes. Its computation takes into consideration non-traded debts, thus providing an accurate representation of a business worth.