CHAPTER TWENTY-FOUR VALUING DEBT How do you estimate the present value of a company’s bonds? The answer is simple: You take the cash flows and discount them at the opportunity cost of capital. Therefore, if a bond produces cash flows of C dollars per year for N years and is then repaid at its face value | Brealey-Meyers VII. Debt Financing 24. Valuing Debt The McGraw-Hill Principles of Corporate Finance Seventh Edition Companies 2003 CHAPTER TWENTY-FOUR VALUING DEB 666 I Brealey-Meyers I VII. Debt Financing Principles of Corporate Finance Seventh Edition I 24. Valuing Debt I The McGraw-Hill Companies 2003 HOW DO YOU estimate the present value of a company s bonds The answer is simple You take the cash flows and discount them at the opportunity cost of capital. Therefore if a bond produces cash flows of C dollars per year for N years and is then repaid at its face value 1 000 the present value is PV -C- C . C 1 000 1 r 11 r2 2 11 rN N 1 rN N where r1 r2 . . . rN are the appropriate discount rates for the cash flows to be received by the bond owners in periods 1 2 . . . N. That is correct as far as it goes but it does not tell us anything about what determines the discount rates. For example In 1945 . Treasury bills offered a return of .4 percent At their 1981 peak they offered a return of over 17 percent. Why does the same security offer radically different yields at different times In mid-2001 the . Treasury could borrow for one year at an interest rate of percent but it had to pay nearly 6 percent for a 30-year loan. Why do bonds maturing at different dates offer different rates of interest In other words why is there a term structure of interest rates In mid-2001 the United States government could issue long-term bonds at a rate of nearly 6 percent. But even the most blue-chip corporate issuers had to pay at least 50 basis points .5 percent more on their long-term borrowing. What explains the premium that firms have to pay These questions lead to deep issues that will keep economists simmering for years. But we can give general answers and at the same time present some fundamental ideas. Why should the financial manager care about these ideas Who needs to know how bonds are priced as long as the bond market is active and efficient Efficient markets .
