Ifwediscountthecashat10%,wewouldvaluethecashat
$90 million instead of the correct value of $200
million—hence the loss in value of $110 million.
Gross Debt, Net Debt, and the Treatment of Cash
In much of Latin America and Europe, analysts net cash
balancesoutagainstdebtoutstandingtocomeupwithanet
debtvalue,whichtheyuseincomputingdebtratiosandcosts
ofcapital.Infirmvaluecalculation,therefore,thedifferences
between using the gross debt approach and the net debt
approach will show up in the following places:
- Assumingthatthebottom-upbetaofthecompanyis
computed,wewillbeginwithanunleveredbetaand
leverthebetaupusingthenetdebttoequity ratio
rather than the gross debt to equity ratio, which
should resultin a lowerbeta and a lowest cost of
equity when using the net debt ratio approach. - Whencomputing thecost ofcapital,thedebt ratio
usedwillbethenetdebttocapitalratioratherthan
thegrossdebtratio.Ifthecostofdebtisthesame
underthetwoapproaches,thegreaterweightattached
tothecost ofequityinthenetdebtratio approach
willcompensate(atleastpartially)forthelowercost
ofequityobtainedundertheapproach.Ingeneral,the
costofcapitalobtainedusingthegrossdebtratiowill
notbethesameasthecostofcapitalobtainedunder
the net debt approach. - Thecashflowstothefirmarethesameunderthetwo
approaches, and once the value is obtained by
discountingthecashflowsbackatthecostofcapital,
theadjustments under thetwo approachesfor debt