Treatment of Zero Coupon Debt in calculation of equity value from EV

rahuljain's picture
Rank: Chimp | banana points 3

While trying to arrive at equity value from EV, Should you reduce par value of a zero coupon debt or current market value as zero coupon debt trades below par always?

Example: let's say EV of a company is 100 with zero debt and zero cash resulting in equity value of 100. The company now decides to raise debt via zero coupon bond and ends up raising 80 debt whose face value is 100.

Assuming the company raised debt at market rates, and all other factors as constant, EV should remain unchanged and therefore equity value should also remain the same.

EV= 100
Debt =80
Cash =80
Equity =100

In the example above I am reducing market value of 80 and not par value. Should I be reducing Debt of 100 and end up with Equity of 80 instead?

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Comments (9)

Oct 20, 2016

Zero coupon debt does not always trade below par. They are often convertible, have equity kickers, asset liens, change of control, or other features that might cause them to trade at or above par (especially with converts). So it's important to understand the details of the zero coupon debt and why it was issued in the first place.

A lot of debt trades below par - do you typically use the trading value of other types of notes when calculating EV? The answer is no, although "EV at market value of debt" can be a useful metric to show side-by-side with traditional EV, especially in the context of pitching the idea of buying the debt in the market as part of a larger acquisition strategy to get the company at a lower multiple.

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Oct 20, 2016

Pretty sure he's asking whether you subtract the carrying value on the books for a straight zero coupon bond or the principal amount. And it should be the carrying value on the books right? Because that is pv of cash flows to bond holders. So in his example, equity value is still 100.

Oct 21, 2016

Let's assume this Zero coupon debt trades below par and does not have a convertible option or equity kickers etc. I would not use the trading value of other types of notes. However a zero coupon bond or OID bond would be at trading/ issued value since it is not issued at par.

Oct 21, 2016

YTM = (face value / current market price) ^ (1/7) - 1

Oct 21, 2016

YTM = (Face Value/Market Price)^(1/n) -1...?

Where n = number of years remaining?

Oct 21, 2016

^ what they said. If you want to know why recall that the present value formula says

PV = FV/(1+y)^t

Where PV is the market price of the bond
FV is the face value of the bond
y is the ytm and
t is the number of years

Solving the above for y gets you the equations noted above

Oct 21, 2016

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