¶ … Value of Money
My SLP company is Wal-Mart. For me I would pay less than $100,000 for this bond, because I know that the $100,000 face value of the bond is not going to have the same purchasing power in a year as it does today. The value of the bond will therefore be less than $100,000, based on the prevailing interest rate. Wal-Mart is a company with a high amount of cash flow that is quite reliable. Thus it is not expected that Wal-Mart would pay much in the way of interest, maybe 2% per year. This implies the value of the bond would be around $98,000.
The discount rate for this bond, based on a $98,000 price, would be 2.04%, as calculated by ($100,000 -- 98,000) / 98000. This reflects the return that the bond offers to the investor.
Target is a company in the same industry as Wal-Mart. I would pay less for a Target bond. Target is a stable enough company, but it does not have the same level of stability and diversification as Wal-Mart does. Therefore I would demand a risk premium for a Target bond, and that risk premium is going to mean that I will pay less for that bond, and therefore earn a bigger return, than I would for Wal-Mart. I would pay $97,000 for a Target bond, which gives a return of (100,000 -- 97,000) / 97,000 = 3.09%.
When one considers the things you want in a company when evaluating debt, you want to see stable cash flows, a lack of long-term debt and a healthy liquidity position. Wal-Mart is an excellent company in this regard, so there are not too many competitors of Wal-Mart that are actually more attractive. One that does have greater appeal is Amazon. While Wal-Mart is one of the largest online retailers, Amazon dominates this space. It has billions in cash, and its...
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