What is Market Value of Debt?

What is Market Value of Debt?

The Market Value of Debt refers to the market price investors would be willing to buy a company’s debt for, which differs from the book value on the balance sheet. A company’s debt doesn’t always come in the form of publicly traded bonds, which have a specified market value. Instead, many companies own debt that can be classified as non-traded, such as bank loans.

Because this debt is reported at book value or accounting value in the financial statements, it is the analysts’ responsibility to calculate the market value, which will be of major importance when calculating the company’s total Enterprise Value.

Market Value of Debt Formula Calculation

When it comes to calculating the market value of debt, it is important first to ascertain debt that is not traded in the market. Such debts include things like bank loans or used credit lines. The next step involves determining the total amount of debt that is paid in interest on a yearly basis.

The face value of the weighted average maturity of the debt is also taken into consideration by focusing on different debts with different maturity debts. Once the current cost of debt is ascertained, then the market value of debt can be ascertained.

The simplest formula for calculating the market value of debt is:

C [(1 – (1/ ((1 + KD) ^t)))/Kd] + [FV/ ((1 + Kd) ^t)]

Where:

C= Interest expense (in dollars)

kd = cost of debt in percentage

t= weighted average maturity in years

FV= the total debt

Factors Influencing Market Value of Debt

The market value of debt and other fixed-income securities is influenced by many factors. It’s important to have a solid understanding of what these factors are, and what impact they have on the value of debt, directionally speaking.

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Factors influencing the market value of debt:

  • Interest rates – the market price of debt has an inverse relationship to interest rates (as rates go up, prices go down)
  • Company performance – the more ability a company has to service its debt (generating more cash flow) the higher the value of its debt will be
  • Value of assets – if the value of the assets that are used as collateral on the debt significantly decline, the market value of debt is likely to decline, too
  • Covenants – lenders set covenants the borrowing company must meet, and if they are breached, then the value of debt would be negatively impacted

When evaluating the market price of debt, it’s important to take all of the above factors into consideration.

Market Value of Debt Importance

One of the reasons why people insist on the calculation of the market value of debt is that its final figure helps in the calculation of the true cost of capital. Likewise, investors and analysts use the financial metric to estimate future projections more so for financing growth and funding.

Companies also rely on this financial metric to make informed financial decisions, especially when seeking financing. Likewise, analysts rely on the market value of debt to ascertain the net worth of a business as it takes into consideration all the debts that a company owes.

Conclusion

Debt represents any obligations that companies accumulate toward third parties. Usually, it is a part of a company’s balance sheet evaluated through its book value.

The market value of debt represents the amount investors will be willing to pay to acquire a company’s debt. It presents a better picture of a company’s debt position and is of significant importance.