Modelling question: debt & Interest schedule in a real model
Quick question, if you are modelling in real terms, how would you adjust your debt repayment schedule to reflect this?
As an example, suppose your model shows that Company A generates $100 CFADS every year in real terms and that you have $50 of debt that amortises straight line over 5 years (i.e. 10 every year). What adjustment would need to be made when paying down this debt with the generated cash given the generated cash flow is in real terms and amortisation payment is nominal?
What is the convention here? Tell me if I'm going crazy.
Thanks
Debt amortization does not show up on the income statement so doesn't affect EBT. Only thing that would affect EBT is interest expense associated with the debt. Amortization of debt is a mandatory repayment which would show up in your debt schedule (CFF).
Are you talking about amortization of fees associated with debt? That would be on your I/S.
Apologies, you are very right. I should have checked my question actually made sense. Have rephrased above
Thanks
Cash flow generated is nominal also, not "real". When you build a model, everything in it is nominal ("observed"). The idea of real as a concept is imputed from nominal and inflation.
Thinking about things in terms of nominal, real and inflation really only matters for your GDP assumption if you are using that as a proxy for long-term growth rate.
If you use a nominal rate, it implies your business is growing because of inflation (price increases, $1.02 vs. $1.00) and real terms (increased volume, selling 101 apples instead of 100).
If you use an inflation assumption for growth, you are only assuming the price increase portion (and your capex should be maintenance capex which converges to depreciation, implies no growth in real asset base - I have ten trucks in my fleet, I depreciate one truck a year and I replace it with one new truck). Change in net working capital should also approach zero.
If your growth rate is nominal, you could debate having a slightly higher capex (some modest growth capex) to show that your real asset base is growing slightly to sell that additional apple.
Otherwise, everything in your model is nominal. Am I missing something in your question?
Yes, so when I say my model is in real terms, I am not assuming any growth from inflation. Changes in cash generated come purely from real changes (e.g. product volumes, product mix etc.).
I feel like I may not be communicating my issue sufficiently clearly. Googling around Ive found this pdf:
http://www.cumpetere.com/Documents/Is%20it%20real%20or%20is%20it%20nomi…
which under pg 2 ("debt service coverage") explains what my model is currently doing. Is this any clearer?
Sorry. Not as familiar with models done on real terms. I've only modeled as nominal.
Anyone else have thoughts on this?
This seems like a weird way to model something but if it is the route you want to go, why wouldn't you just apply a deflation factor to each year's debt service cash flows, or an inflation rate in your non-debt cash flows.
So if you were doing the deflation method, assuming 2% annual inflation, if your year 2 debt service for interest and principal was going to be $100, you would just convert that to a "real" $100 by dividing by 1.02^2. I've never seen this but that would logically be the way to think about I would assume.
This is what I thought would be a way to correct for this (and i imagine by this logic you would also have to adjust the interest rate on debt to be "real" and divide the rate by 1.02), but like you have never seen this done before.
Anyone with experience modelling in real terms able to chime in? Alternatively, does anyone have some real models they would be willing share for me to take a look at?
@ask768" Have you got the answer to your question?
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