A firm’s debt consists of money it has borrowed and must repay, such as bonds and loans. A firm lists the book value, or accounting value, of its debt on its balance sheet. This differs from the market value of debt, which is the price an investor would pay for it on the open market. Because some of a firm’s debt, such as a line of credit, may not be publicly traded to determine its market value, treat all of a firm’s debt as one bond and use the bond pricing formula to estimate its market value.
Search for the section of a company’s 10-K annual report in which it lists its different types of debt. Obtain a company’s 10-K annual report from the U.S. Securities and Exchange Commission’s EDGAR online database.
Identify each piece of debt’s maturity, which is when it becomes due, and each piece’s face value, which is the amount due at maturity. For example, assume a company has a $100,000 bank loan with a five-year maturity and a $150,000 corporate bond issue with a 10-year maturity.
Identify in the 10-K annual report the current cost of the company’s debt, which is the interest rate it would pay if it took on new debt. Also find the company’s interest expense, listed on its income statement, which you can find in the annual report. In this example, assume the company has $14,000 in interest expense and a 7 percent current cost of debt.
Add together the face value of each piece of debt to determine the total face value of debt. In this example, add $100,000 and $150,000 to get $250,000 in total face value.
Multiply each piece’s face value by its maturity. Add together each result. Then divide this result by the total face value to determine the debt’s weighted average maturity. In this example, multiply $100,000 by 5 to get $500,000. Multiply $150,000 by 10 to get $1.5 million. Add $500,000 and $1.5 million to get $2 million. Then divide $2 million by $250,000 to get a weighted average maturity of eight years.
Substitute the appropriate values into the bond pricing formula: C[(1 - (1/((1 + R)^T)))/R] + [F/((1 + R)^T)]. In the formula, C represents the annual interest expense, R represents the current cost of debt, T represents the weighted average maturity and F represents the total face value of debt. Continuing with the example, substitute the values to get $14,000[(1 - (1/((1 + 0.07)^8)))/0.07] + [$250,000/((1 + 0.07)^8)].
Solve the formula to calculate the market value of the firm’s debt. Continuing with the example, solve the formula to get a market value of debt of $229,100.