From what I can gather the borrower in question has defaulted or is about to default and is asking to restructure the loan. In such a scenario the borrower is at the lender’s mercy because there are remedies available to the lender if the borrower does default. The choice facing the lender is whether the loan is (or is likely to be) worth more to it a) restructured, with a lower interest rate (and perhaps other terms) that the borrower will be able to meet, or b) in default, with the lender pursuing its resulting remedies. It is impossible to offer an opinion on that without understanding the situation in great detail. In any case, it’s great that the borrower has thrown out a number as a potential new interest rate on the loan, but the lender needs to evaluate it in light of all of the relevant circumstances to determine whether it’s acceptable (and the lender should really be dictating the terms in a scenario like the one described above, not the borrower). The WACC for the region that the borrower is located in may be a somewhat useful data point, but it isn’t anything more than that. A “WACC for West Africa” to the extent it were even available/reliable would be an average number that would (absent some indication to the contrary, which you haven’t provided) presumably include both equity and debt, big companies and small, companies in a variety of industries, and companies in the better-run bits of West Africa as well as the worse-run ones. The appropriate interest rate in your scenario will be for a certain kind of debt with certain kinds of terms owed by a certain kind of company with certain characteristics of a certain size located/operating in certain areas. Surely whoever made the loan in the first place knows a great deal about the borrower and its business and is in a much better position to evaluate the borrower’s proposal than a bunch of folks on an anonymous message board who know nothing about the particulars of the deal. No offense intended, but it actually strikes me as very peculiar that someone would be lending money to African borrowers while knowing so little about that business that he or she would need to solicit advice on an anonymous message board to try to avoid having someone “pull a fast one on him.” Am I missing something?
Haha…if I have need a solution, AF is where I go 
But more seriously, the guy’s someone I know, so just trying to do my bit and help him out with some info. The deal was done a few years ago I guess and now the company has defaulted and saying it would be able to pay back the loan only after applying the WACC according to him. A lot of businesses in Africa and India are done on the basis of trust and personal agreements. Unfortunately, its not as structured like the west where you would be consulting lawyers things like that. I am sure you wouldn’t be surprised by this at all. So, its just a case of bad luck here and this obviously comes with high risk such as the one that’s taking place with him. I don’t know much about the deal too; what he told me is pretty much what I was requesting info. on. I just thought it was strange they would throw numbers and words like WACC and the application on the deal when he said it’s a loan. I just wanted to know if that’s how defaults played out because I am not an expert on this. I am just applying my basic CFA knowledge and common sense to provide him with whatever info. and avoid getting screwed. One of the ways I get info. is via AF. So I thought why not give it a shot? It’s strange I agree, but it’s good to know there are smart people around to talk to. But yea, that’s informative post you’ve provided. Unfortunately, like I said, I don’t know much about the deal myself, but I don’t want to come across as ignorant when I told him I’ll try and help him out. Hope you understand.
That makes sense; hope I didn’t sound like too big a smart aleck. I don’t see any reason why a WACC for West Africa (assuming a reliable one is available) wouldn’t be a useful data point in that scenario; I don’t think there’s any magic to it. I would think the lender would want to critically evaluate how appropriate that figure is and how it would need adjustment, though, rather than just accepting it, at least to the extent the lender has any negotiating leverage. I’m sure the business and legal environment relevant to this scenario is indeed different than the one(s) most of us on here are used to. On one end of the spectrum in a situation like this you would have a senior lender whose loan is overcollateralized enforcing its remedies in a jurisdiction like a US state or the UK, in which case the lender would run the show and could take possession of the collateral, sell it and be made whole if it didn’t want to restructure or couldn’t come to an agreement with the borrower; it doesn’t sound like that’s the situation here. On the other end of the spectrum you might have a “lender” who has just handed over a pot of money on someone’s word or a handshake (whether in Africa or somewhere else), in which case it would be left with few (legal) remedies and might count itself fortunate that the borrower was offering to repay anything at all; I certainly hope that’s not the situation here. Your friend’s situation is probably somewhere in between. If the amount of money at stake is big enough it is probably worth talking to a good lawyer in the relevant jurisdiction to find out what legal remedies and how much negotiating leverage the lender has, if any, before negotiating with the borrower.
sparty419 Wrote: ------------------------------------------------------- > Matt, thats good info. there. I’ll check up on > that. Just to avoid harping on the same topic, I > guess 21% can be justified then, but would it be a > correct application of the rate on a loan payment? > I would assume just the borrowing rate or current > market rate would be used. Thanks. the use of WACC is interesting but it might be commonplace in an area where both equity and debt financing are difficult to attain and thus, difficult to price. maybe they actually mean CC not WACC. who knows, maybe the WACC number is a World Bank/IMF established number for cost of capital that allows businesses to operate with some concrete, research-based, benchmark number. to be honest, this would make the most sense to me. who knows, maybe the loan has some equity component like a convertible debenture…
wait, i think i’ve got it. if the company defaulted, wouldn’t the cost of debt and WACC be the same, assuming equity is fully pooched? i mean, if there is no intention to bring in new equity from the get-go, the debt holder is essentially taking all of the risk so would need to be compensated for said risk. because they are taking all of the risk, they are receiving interest payments and they have a maturity, maybe there is a World Bank/IMF established rate for average capital and they are using that for pricing because the debt represents all (average) capital but does retain its debt-like privileges of seniority over future equity issuance and coupon payments and a term-certain maturity. whomever establishes the WACC, i do think WACC makes sense if equity is dead.
Since the WACC number was suggested by the borrower I’d think it’s probably more likely to be just a number that the borrower thinks it would be comfortable with; justifying it with analysis would seem to be more incumbent on the lender and likely only done in advance/offered up by the borrower if it knew the lender was going to do it itself/ask for it, which seems not to be the case here. It may well be a benchmark number produced by someone like you say, though.
MattLikesAnalysis Wrote: ------------------------------------------------------- > wait, i think i’ve got it. if the company > defaulted, wouldn’t the cost of debt and WACC be > the same, assuming equity is fully pooched? i > mean, if there is no intention to bring in new > equity from the get-go, the debt holder is > essentially taking all of the risk so would need > to be compensated for said risk. because they are > taking all of the risk, they are receiving > interest payments and they have a maturity, maybe > there is a World Bank/IMF established rate for > average capital and they are using that for > pricing because the debt represents all (average) > capital. The equity would only be eliminated in a bankruptcy proceeding; since the borrower’s trying to renegotiate, presumably it’s trying to avoid wiping out the existing equity. In any case, even if the current debtholders became the equity owners and there was only one element of the borrower’s cost of capital (not saying that would necessarily be the case, but just for the sake of argument) that would eliminate only one factor affecting the analysis and you would still have things like company size, industry, specific areas where it operates, etc. to think about in determining an appropriate rate; the WACC still wouldn’t be one size fits all.
I think it’s pretty likely that the borrower has just seized on the WACC number in question (for which there may be a good basis, or not so much) as a seemingly plausible shortcut to justify an interest rate that the borrower is comfortable with, either in good faith or not so much.
Captain Windjammer Wrote: ------------------------------------------------------- > MattLikesAnalysis Wrote: > -------------------------------------------------- > ----- > > wait, i think i’ve got it. if the company > > defaulted, wouldn’t the cost of debt and WACC > be > > the same, assuming equity is fully pooched? i > > mean, if there is no intention to bring in new > > equity from the get-go, the debt holder is > > essentially taking all of the risk so would > need > > to be compensated for said risk. because they > are > > taking all of the risk, they are receiving > > interest payments and they have a maturity, > maybe > > there is a World Bank/IMF established rate for > > average capital and they are using that for > > pricing because the debt represents all > (average) > > capital. > > The equity would only be eliminated in a > bankruptcy proceeding; since the borrower’s trying > to renegotiate, presumably it’s trying to avoid > wiping out the existing equity. In any case, even > if the current debtholders became the equity > owners and there was only one element of the > borrower’s cost of capital (not saying that would > necessarily be the case, but just for the sake of > argument) that would eliminate only one factor > affecting the analysis and you would still have > things like company size, industry, specific areas > where it operates, etc. to think about in > determining an appropriate rate; the WACC still > wouldn’t be one size fits all. it is one size fits all if you have a comparable. if you can find a WACC for a similar company (based on size, industry, geography, etc) then it is appropriate. even if you don’t have a comparable, you can establish a cost of debt and equity, propose a future D/E ratio (likely linked to the average D/E for the industry) and apply it to the debt.
MattLikesAnalysis Wrote: > it is one size fits all if you have a comparable. > if you can find a WACC for a similar company > (based on size, industry, geography, etc) then it > is appropriate. even if you don’t have a > comparable, you can establish a cost of debt and > equity, propose a future D/E ratio (likely linked > to the average D/E for the industry) and apply it > to the debt. The “WACC for a similar company” you’re talking about is something different from the general 21% “WACC for West Africa” proposed by the borrower and is a step toward the sort of analysis I’m suggesting the lender needs to do, so I guess we agree on that. As for the rest, it seems circular to me since your first step - “establish a cost of debt and equity” - is exactly the goal the borrower and lender are trying to get to.
but the cost of debt for this industry, region, etc is different than the cost of WACC when you and do not have equity as protection. how many countries in W. Africa even have a stock exchange? i have no idea how you issue equity in those countries, thus why you can’t just use a cost of debt plus some arbitrary # for pricing, you need to use a WACC based on your future expected equity issuance at least until maturity. to make its easy to assume, lets assume the debt matures on the same day that they plan on issuing new equity.
Wow…thanks for your thoughts and analysis. This is actually really educational to read all this and try to apply it in the real world. I’ve asked my friend to email the borrower to ask for specific breakdown of the rate just to get an idea of how they are conjuring up that number. It’ll be interesting to see as well how things are done in that region of the world. Just one confusion from reading your post, (@matt), and not related to this case as much, but are you saying that if a company files for bankruptcy or liquidation, the equity and debt holders have the same rates on their books? What if the debt holder has a loan of Libor+x% that was agreed upon? That gets ignored and a new WACC rate is applied? Not sure if I am getting that.
sparty419 Wrote: ------------------------------------------------------- > Wow…thanks for your thoughts and analysis. This > is actually really educational to read all this > and try to apply it in the real world. I’ve asked > my friend to email the borrower to ask for > specific breakdown of the rate just to get an idea > of how they are conjuring up that number. It’ll be > interesting to see as well how things are done in > that region of the world. > > Just one confusion from reading your post, > (@matt), and not related to this case as much, but > are you saying that if a company files for > bankruptcy or liquidation, the equity and debt > holders have the same rates on their books? What > if the debt holder has a loan of Libor+x% that was > agreed upon? That gets ignored and a new WACC rate > is applied? Not sure if I am getting that. no i’m saying that in liquidation, if equity loses all value, yet bonds retain some value, the cost of capital of the bonds going forward (post-loss on bankruptcy filing) would be equal to a middle-ground between bonds and equity, because they act like equity (assume total loss) until new equity is issued but they have a set maturity date that the corporation has to settle. usually in a reorg like this the bonds will be converted to equity but should they come out without conversion, and equity has little to no value, than the bonds should trade closer to a comparable company’s WACC rather than at the cost of debt. the scenario i am explaining is mostly theoretical as 99 times out of 100, the bonds will at least be partially converted to new equity should old equity lose all or most of its value. to answer your question directly, if equity has no value, it has no cost of capital. the debt holders are the only capital around and their cost of capital rises from its originally established cost of debt to a number between the original cost of debt and equity, pre-liquidation. a number that is close to the WACC of similar companies should the overall risk profile resemble that of similar companies, post-reorg.
Hmm…that makes sense. Very interesting concept. Never knew that it could work like that. So then basically, assuming we are talking about chap.7 bankruptcies, where companies close shop and stop being a going concern, then there is no question of converting anything here. So, in this case again, equity would not have any value right? And debt holders having seniority will get their monies on a rate that is close to WACC or somewhere in between. This is what you are saying, just to confirm.
MattLikesAnalysis Wrote: ------------------------------------------------------- > but the cost of debt for this industry, region, > etc is different than the cost of WACC when you > and do not have equity as protection. how many > countries in W. Africa even have a stock exchange? > i have no idea how you issue equity in those > countries, thus why you can’t just use a cost of > debt plus some arbitrary # for pricing, you need > to use a WACC based on your future expected equity > issuance at least until maturity. to make its easy > to assume, lets assume the debt matures on the > same day that they plan on issuing new equity. That’s nonsense; every company that has an owner has equity and a cost of equity capital. I own a single-member LLC and my ownership interest is equity and has an associated cost of capital (though I don’t know what it is). The only way the borrower here could have no equity would be if it were not a legal entity at all.
MattLikesAnalysis Wrote: ------------------------------------------------------- > sparty419 Wrote: > -------------------------------------------------- > ----- > > Wow…thanks for your thoughts and analysis. > This > > is actually really educational to read all this > > and try to apply it in the real world. I’ve > asked > > my friend to email the borrower to ask for > > specific breakdown of the rate just to get an > idea > > of how they are conjuring up that number. It’ll > be > > interesting to see as well how things are done > in > > that region of the world. > > > > Just one confusion from reading your post, > > (@matt), and not related to this case as much, > but > > are you saying that if a company files for > > bankruptcy or liquidation, the equity and debt > > holders have the same rates on their books? > What > > if the debt holder has a loan of Libor+x% that > was > > agreed upon? That gets ignored and a new WACC > rate > > is applied? Not sure if I am getting that. > > > no i’m saying that in liquidation, if equity loses > all value, yet bonds retain some value, the cost > of capital of the bonds going forward (post-loss > on bankruptcy filing) would be equal to a > middle-ground between bonds and equity, because > they act like equity (assume total loss) until new > equity is issued but they have a set maturity date > that the corporation has to settle. usually in a > reorg like this the bonds will be converted to > equity but should they come out without > conversion, and equity has little to no value, > than the bonds should trade closer to a comparable > company’s WACC rather than at the cost of debt. > the scenario i am explaining is mostly theoretical > as 99 times out of 100, the bonds will at least be > partially converted to new equity should old > equity lose all or most of its value. > > to answer your question directly, if equity has no > value, it has no cost of capital. the debt holders > are the only capital around and their cost of > capital rises from its originally established cost > of debt to a number between the original cost of > debt and equity, pre-liquidation. a number that is > close to the WACC of similar companies should the > overall risk profile resemble that of similar > companies, post-reorg. Again, no company has its equity eliminated without it being replaced; no company has only debt in its capital stcuture.
sparty419 Wrote: ------------------------------------------------------- > Hmm…that makes sense. Very interesting concept. > Never knew that it could work like that. So then > basically, assuming we are talking about chap.7 > bankruptcies, where companies close shop and stop > being a going concern, then there is no question > of converting anything here. So, in this case > again, equity would not have any value right? And > debt holders having seniority will get their > monies on a rate that is close to WACC or > somewhere in between. This is what you are saying, > just to confirm. When a company is liquidated, debtors don’t get their money “on a rate”, they get it in accordance with the amounts they’re owed and their respective priorities (secured or not, etc.).
but thats exactly what i’m arguing. if a company has debt and equity, pre-bankruptcy and the equity is worth squat, following the conversion from debt to either all equity or part-equity, part-debt, the debtholders cost of capital has gone up since it was JUST a debtholder, but its cost of capital is not as high as it was for equity, pre-liquidation. essentially, it represents a WACC for a similar company in a similar industry with a similar financial condition. for example: pre-bankruptcy: debt k = 8% equity k = 30% post bankruptcy: debt k for possible new debt (not debtholders that entered bankruptcy) = 5-6% equity k (consists entirely of the old debtholders) = 12-18% after reorganization, the debtholders of the bankrupt company would assume more risk as its likely the assets cannot be sold for 100% of debt obligations. this is at the expense of the old equityholders. this increased risk is represented in a higher cost of capital. whether the old equityholders equal 0%, 1% or 10% of the ‘newly formed common shares’, the premise remains the same, debt holders assume more risk. the pre-bankruptcy WACC may be one of the best starting points to establishing the post-bankruptcy cost of capital for whatever securities the debtholders receive post-bankruptcy. we’re not talking interest rates here, we’re talking cost of capital. the cost of capital of the organization should stay the same if you have the same amount of capital especially considering the cost of capital of debt rises to essentially eliminate any tax advantage over a normalized equity cost of capital, pre-bankruptcy. if the old equityholders are dead, it doesn’t matter whether the debtholders are reorganized to get 1% equity and 99% debt for their old debt or whether they get 100% equity and 0% debt, their cost of capital is the same as they remain the sole owners of the business in either scenario. they essentially assume the WACC of an otherwise healthy business assuming they cleared up any operating issues (downsizing, etc) during bankruptcy and there are no new capital sources.
west africa=nigeria=send $10K to my associate via western union to collect government funds in excess of $2.5M. you calculate the expected return yourself
but in more seriousness, morningstar publishes an international cost of capital report (formerly Ibbotson assiciates) which uses several different models to supposedly measure the cost of capital in different countries, including west african nations