forecasting debt and interest

7/29/2019 Forecasting Debt and Interest

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Forecasting Debt and Interest

Debt

The issuance and repayment of debt is a balancing act that takes into account the cash available to thecompany. Holding on to too much cash is detrimental to the company because of the opportunity costwhile too little cash could result in a company being unable to pay off its debt obligations.

The steps to calculate debt repayments are as follows:

o Determine the free cash flow at the start of the year (everything but financing activities) andadd it to the cash balance at the start of the year

o Determine a minimum cash balance that the company would like to have on hand andsubtract it. This figure represents the FCF available for financing activities.

o Add/Subtract the cash flows from financing activities apart from debt. By now, these shouldall have been calculated.

o Sum up the cash flows and that is what is available to repay the debt.o Determine the effects of net debt (issuance and repayment). Look in the management

footnotes to determine when debt is due and when it is required.o Is the cash available enough to repay the net debt?

If so, then pay it off. The remainder is what is available to repay short term debt. If the number is negative, then you must draw from the short term debt to pay off the

long term debt. Add back your cash reserves.

Interest

Using the management notes, calculate the historical interest rates charged on the debt. This amount

may not match up with the interest expense shown in the income statement. This can be caused by thepayment and repayment of short term debt or through the use of derivatives to convert floating tofixed or fixed to floating. Itll be too difficult to reconcile the differences, so add a plug.

Forecast the future interest rates based on debt and make reasonable assumptions for Other interest.

Example: Cisco Debt and Interest

Step 1: Create a new sheet and link the free cash flow and cash balance from the statement of cashflows and balance sheet. Estimate the minimum cash balance that the company should have on hand.
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Step 2: Add the cash flows from financing that are unrelated to debt. The sum of the FCF and cashfrom financing activities is the cash that the company has to service its debt.
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Step 3: Add the debt that the company has on its books and forecast it out. Go through previous years

financial statements to get the figures. FY2010 and FY2009 figures can be found on page 62 of theFY2010 AR. 2008 figures can be found on page 66 of the FY2008 AR. Forecast future debt levelsbased on each notes due date.

Step 4: Each year, a portion of LT debt becomes current. This is linked from the balance sheet to

arrive at the net debt number. Link the historical figures first.
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Step 5: The financing cash flows are the respective sums of proceeds from issuance and repayment ofdebt. We can use a formula to calculate them instead of manually entering the figures.
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Step 6: Add conditional sums to determine the total issuance and repayment of LT debt. This will belinked to the cash flow statement. Only sum the lines that are related to long term debt.

Step 7: Calculate the historical other line. This is the sum of the other line on the CF statement and theremaining debt line items.
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Step 8: We need to reconcile the differences between the cash flows from financing on the CF sheetwith what we have calculated here.
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Step 9: Forecast debt repayment based on each notes due date. For FY2011, 3000 will pay off the

5.25% notes due 2011. This leaves an extra $96 from the short-term debt that is unpaid. We willforecast this in the other line.

The year before long term debt is paid off, that portion becomes current. Total long term debt mustthen go down and short term debt must go up. Make sure you understand why we are using the next

years repayment forecast to predict the current years current portion of long term debt.

Note the formula of the other line has also changed.

Step 10: Sum the free cash flow available for debt and the net proceeds from debt to determine thecash available to pay down the revolver.

Add/subtract borrowing/paydown of ST debt and add your minimum cash balance to determine yourending cash balance. If the ending cash balance value is negative, then you may either issue more debtabove or increase usage of ST debt. This is very much a judgment call.
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Step 11: Link the cash flow statement.
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Step 12: Link the debt line items to the balance sheet.

Step 13: Link the ending cash balance from the CF statement to the balance sheet.
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Step 14: The last thing well need to do is to estimate the companys interest payments. Start byentering the interest rates of the notes. For 2008, you will need to refer to the financial statements todetermine what the floating rate note is based on. Pg 40 of the FY2008 AR shows the effective ratethe company is paying on its notes.
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Step 15: Estimate the interest payments by multiplying the amount of debt by the interest rate. Notethat there are 53 weeks in 2010 which is why you need the week adjustment.
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Step 16: Once you have calculated interest expense, calculate the other interest line by finding thedifference between what is on the income statement and what you calculate. We have elected tostraight-line the other interest line item, but you may elect to leave it blank.

Step 17: Finally, link the interest payments to the income statement. We have also straight-lineforecast the Interest Income.
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OIS Discounting and OTC Derivatives: Demystifying the Confusion

Market participants are seeking a deeper understanding when it comes to the potential impact ofmoving to OIS discounting. The recent uptick in OIS curves as the valuation discounting basisfor collateralized derivative deals, and the use of dual-curve pricing, has inspired us to more

closely examine the use of separate forecasting and discounting curvesin addition to exploringthe impact of newly proposed ISDA Standard Credit Support Annex (SCSA) on todays financialinstitutions. On November 8th, leading derivative analytics provider Numerixalong withindustry expert, Dr. Greg Cripps, President of Prism Valuationhosted a webinar to help

demystify the confusion behind OIS discounting in the OTC marketplace.

The Evolution Toward Separate Forecasting and Discounting Curves

In 2008, the world dramatically changed... It is well-known that prior to the financial crisis, lifewas simpler with market participants mainly relying on the LIBOR curve to forecast the LIBORrate and discount the cash flow. Todays market participants realize that we need separate

forecasting and discounting curves, Dr. Cripps explained. The post-crisis financial world isvery different, and the old way is just not going to work anymore, he said.

When it comes to the current methods for discounting future cashflows, the market is evolvingtoward OIS discounting of future cashflows assuming two-way collateral agreement withoutthresholds. Most believe that the current situation with threshold and multi-currency CSAs istoo complex and unsustainable and that a more standardized CSA would be a better approach,Dr. Cripps added.

The proposed ISDA SCSA, targeted for 2012, is in line with the SwapClear model, and

promotes the following standards: Collateral is posted in major currencies

(USD,EUR,GBP,CHF,JPY); Collateral is posted in the natural currency of any deal exposure;and OIS curve discounting is used to calculate values.

While things are evolving, some people are still using the old practices, with LIBOR

discounting prevailing in many Back Offices, he said. But, we are also seeing a new trendemerging with most valuation vendors offering the option to use OIS discounting.

What is the Curve Generation Recipe?

In the new environment, the curve generation recipe is to use one curve for discounting and adifferent curve for forecasting, Cripps reiterated.


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Potential Impact of Moving from LIBOR to OIS Discounting

Examples Swap = USD10MM, 25Y, Rec 5%, Pay 3M Libor

PV (OIS) = 3,885,938, PV(Libor) =3,781,256, +104 bps

Swaption = EUR10MM, 10Y->20Y, RTR = 5%PV (OIS) = 1,438,128, PV(Libor) = 1,385,317, +53 bps

Zero Swap = USD10MM, 20Y, Rec 5%, Pay Libor compoundedPV (OIS) = 4,798,006, PV(Libor) = 4,602,159 , +196 bps

Inflation Swap = GBP10MM, 40Y, Receive 3.5%, Pay inflationPV (OIS) = 499,138, PV(Libor) = 451,912, +47 bps

Looking Ahead: Practical Solutions for Todays OIS Challenges

Looking toward the future, we can see that the valuation of derivatives requires forecastingcurves, dependent on an underlying indexin addition to separate discounting curves, dependenton counterparty credit or funding of collateral. The new ISDA SCSA effort will significantly
http://blog.numerix.com/.a/6a011570f0b826970c015392f8ce68970b-pihttp://blog.numerix.com/.a/6a011570f0b826970c015436cc49ae970c-pihttp://blog.numerix.com/.a/6a011570f0b826970c015392f8ce68970b-pihttp://blog.numerix.com/.a/6a011570f0b826970c015436cc49ae970c-pi


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alleviate complexity issues, but many legacy trades will likely need to be managed under theiroriginal CSAs. In addition, valuation models will need to be updated for CVA calculations andOIS discounting.

Dr. Thomas Davis, VP of the Client Solutions Group at Numerix, explained the broad

capabilities of the Numerix CrossAsset library when it comes to multi-curve pricing and OISsupportsuch as the ability to price linear instruments with multi curves; bootstrapping OIS(EONIA, SONIA, MUTAN) curves; and the additional OIS functionality that Numerix willintroduce in January, including the calibration of stochastic models. So, stay tuned

For more information on OIS Discounting and to listen to the wide-range of thought-provokingquestions and answers generated in the webinar discussion, you can access a replay of thewebinarhere.
http://www.numerix.com/Webinar-Details/r/WEBINARS-846http://www.numerix.com/Webinar-Details/r/WEBINARS-846http://www.numerix.com/Webinar-Details/r/WEBINARS-846http://www.numerix.com/Webinar-Details/r/WEBINARS-846

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