Abstract
Abstract. The objective of this article is theoretical and methodological justifying of determining algorithm of the cost of debt capital for enterprises functioning in emerging markets (EM). The methods of research: analysis and synthesis, system analysis, comparative analysis, empirical and statistical methods, factor analysis. Results. In this article key determinants of interest rates on debt capital for enterprises and their impact on the procedure of discount rate calculation are determined. The issue of the cost of debt calculation of enterprises in condition of absence of complete information concerning systematic and non-systematic crediting risks is studied. Differences between interest rate on the loan fixed in credit agreement and expected by creditors the cost of debt are identified. It is determined that the key factor impacting the deviation level of market value of debt capital from the nominal, and respectively, deviation of the cost of debt from the cost of capital is probability of default (PD). At the minimum values of PD, the contract interest rate corresponds to the rate of cost of debt and it is advisable to use it for discount rate calculation. Critical analysis of alternative methodological approaches of the cost of debt calculation is made. Ways of integrating of market information concerning credit default swaps into the process of expected cost of debt calculation are justified. Factors of shadowing of rates of the cost of debt and ways of reducing of shadow transactions’ level in the credit market are identified. Conclusions. At high PD values, expected by market premium for default risk may exceed the contract interest rate, which necessitates constant monitoring of credit risks and appropriate adaptation of interest rates. In the paper the algorithm of such adaptation are proposed. It is shown that in the case of non-use of interest rates adjustment taking into account changes in PD, CDS and LGD, premium for creditors’ systematic risk can differ significantly from market values of similar enterprises (peer-group), and estimated value of the cost of debt can acquire negative values. Contract (promised) interest rate should be set in such way that the premium for systematic risk of providing debt capital will be at the level of similar companies and does not change significantly as a result of probability of default changes. If in practice the opposite situation occurs, it is the evidence of contract interest rate shadowing, absence of effective system of assessment and management of credit risks. For solving the problem of interest rate transparency and filling of information gaps concerning PD borrowers in EM countries, should intensify CDS market. Keywords: debt capital, default probability, non-performing loans, credit default swap, credit spread, debt capital premium, shadow economy. JEL Classification E47 Formulas: 16; fig.: 0; tabl.: 3; bibl.: 15.
Highlights
Qualitative assessment of assets, financial instruments and investment projects is impossible without a discount rate, which is mostly determined using WACC algorithm
The cost of debt shows expected amount of debtor payments in favor of creditor and corresponds to the sum of risk-free interest rate and expected premium for systematic risk. The latter should not be equated with the credit spread, which is part of contract interest ratecalculation
The size of credit spread may be equal to expected credit risk premium only for borrowers with minimum probability of default
Summary
Qualitative assessment of assets, financial instruments and investment projects is impossible without a discount rate, which is mostly determined using WACC algorithm. In EM countries, in particular in Ukraine, mostly used approach for calculation of discount rate, according to which the rate of return on debt capital is not the expected rate of return on invested capital, but interest rates fixed in appropriate agreements These rates correspond to so-called promised yield and based on ex-post assessments, take into account non-systematic risks and cause erroneous calculations of discount rate. From both theoretical and practical point of view, the cost of debt for enterprise will always be lower than contract interest rate. The problem of correct calculation of discount rates in the EM countries is escalated by absence of effective stock market in which debt financial instruments can be traded, as well as financial relations’ shadowing [13]
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