Many companies had debt trading at distressed levels and very high yields.
Was cost of debt higher than cost of equity even though in theory this shouldnt happen because debt is more senior and cash flows more stable?
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Cost of debt will be lower than cost of equity- in essence the two move in tangent, and therefore if debt is extremely risky, then equity will follow suit.
Please do not use religious innuendo on Wall St. Oasis.
no way, cost of debt was less for every company i looked at than cost of equity...
Using CAPM and pulling historical market returns (e.g. last 30 years S&P 500) may give you a lower cost of equity in theory, yes. However, if you think in terms of risk, the equity holders are still lower in the capital structure. That being said, you need to make an adjustment to your CAPM to adequately compensate for the economics factors (e.g. you could use emerging market cost of equity).
I believe M&M theories discuss this from an academic standpoint.
robface, curious if you were looking at book value of debt or market value when comparing to cost of equity?
i suspect that using market value of debt and some type of 2 year range of data to find beta/cost of equity, you might run across some companies where the cost of debt was theoretically higher than the cost of equity (even though this should not be the case). If this did occur, then in theory the company should be buying back debt to reduce its wacc, but that's counterintuitive and likely restricted by bond/credit indentures as well as creeping tender rules.
Anyway, was just curious if anyone else had run across this situation and if so how they viewed it?
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