Cost of equity

[FatOtt]

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Let's say your numbers were the market prices, that's a change of 22% or about equivalent to a downgrade from BBB to BBB-. Do you really think that's all the true cost of debt changed?

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All right, I just did some quick calculations. First, the company is claiming in their 10-K that the figures I gave were the market values of their structured debt (estimated based on dealer quotes). So I think it's reasonable to say they actually are the market values.

Let's take a look at the implied YTM of these items. We're looking at two notes, one issued on 12/16/98 (face value of $125 million, maturity 12/15/2005, coupon 10.75%), one issued on 4/23/2001 (face value of $150 million, maturity 4/15/2008, coupon 12.25%). I assumed that coupon payments were made annually on the anniversary date, so that coupon payments of $13.4375 million were made annually on 12/15 for the first issue and coupon payments were made annually on 4/15 for the second issue.

At 7/1/2003, when the fair value (market value) of these bonds totaled $274.9 million, I calculate a weighted yield to maturity of 11.86% for the two bonds.

At 7/1/2004, when the fair value was $225.3 million, I calculate a weighted yield to maturity of 21.79% for the two bonds.

That's what I'm talking about when I say that the firm's cost of debt increased significantly. Also, these are relatively short-term maturities. The first issue expires about 18 months after the 10-k, while the second one expires about 4 years after the 10-k. I suspect that change in cost of debt would be much more substantial for longer-duration instruments.

I don't mean to be argumentative, I just happen to be interested in this stuff.

[Evan]

Okay man, you're obviously doing your homewokr here. I think we're getting too cuaght up in an irrelevant example and losing track of the real discussion. Maybe a more direct example will be better

Let's say a company has ZERO on balance sheet debt. None, nothing, interest expense is zero. But, they have a ton of operating leases. This company will have no bond rating and no publicly traded debt to quote. This does NOT mean that their cost of debt is zero. A good example of such a company is Bed Bath and Beyond (although I don't think they have zero debt, it's very very low and their operating leases are MUCH bigger).

My only point is that market quotes are not a good way to attain your cost of debt. At times they will be right, when recetn trades/issues were long ago they will not be. When companies don't have public debt they will not be. That is all I'm trying to say.