Reproduced below is the debt footnote from the 2013 10-K report of Dell Inc. a.

ID: 2772221 • Letter: R

Question

Reproduced below is the debt footnote from the 2013 10-K report of Dell Inc.

a. What is the amount of long-term debt reported on Dell’s February 1, 2013, balance sheet? What are the scheduled maturities for this indebtedness? Why is information relating to a company’s scheduled maturities of the debt useful in an analysis of its financial condition?

b. Dell reported $270 million in interest expense in the notes to its 2103 income statement. In the note to its statement of cash flows, Dell indicates that the cash portion of this expense is $279 million. What could account for the difference between interest expense and interest paid? Explain.

c. Dell’s long-term debt is rated Baa1 by Moody’s, BBB+ by S&P, and BBB+ by Fitch. What factors would be important to consider in attempting to quantify the relative riskiness of Dell compared with other borrowers? Explain.

d. Dell’s $300 million 5.4% notes traded at 69.50 or 69.5% of par, as November 2013. What is the market value of these notes on that date? How is the difference between this market value and the $300 million face value reflected in Dell’s financial statements? What effect would the repurchase of this entire note issue have on Dell’s financial statements? What does the 69.50 price tell you about the general trend in interest rates since Dell sold this bond issue? Explain.

e. Examine the yields to maturity of the three bonds in the table above. What relation do we observe between these yields and the maturities of the bonds? Also, explain why this relation applies in general.

February 1, 2013 February 3, 2012 Long-Term Debt (in millions) Senior Notes $ 400 $400 million issued on June 10, 2009, at 3.375% due June 2012 ("2012 Notes") $600 million issued on April 17, 2008, at 4.70% due April 2013 ("2013A Notes") $500 million issued on September 7, 2010, at 1 .40% due September 2013 $500 million issued on April 1, 2009, at 5.825% due April 2014 $300 million issued on March 28, 2011, with a floating rate due April 2014 ("2014B Notes") $400 million issued on March 28, 2011, at 2.10% due April 2014 $700 million issued on September 7, 2010, at 2.30% due September 2015 1) $400 million issued on March 28, 2011, at 3.10% due April 2016 (b) $500 million issued on April 17, 2008, at 5.65% due April 2018 $600 million issued on June 10, 2009, at 5.875% due June 2019 b) $400 million issued on March 28, 2011, at 4.825% due April 2021 $400 million issued on April 17, 2008, at 6.50% due April 2038 $300 million issued on September 7, 2010, at 5.40% due September 2040 2 2 0 8 500 300 2 701 401 502 7 3 501 602 398 398 300 Senior Debentures $300 million issued on April 3, 1998, at 7.10% due April 2028 ("Senior Debentures") ( 379 Other Long-term structured financing debt Less: current portion of long-term debt Total long-term debt (1,618) 5,242 (924) 6,387

Explanation / Answer

Answer (a)

Total Long Term Debt reported on 1st February 2013 in Balance Sheet

Total Long Term Debt = Total Debt – Total Short Term Debt

= $ 9085 - $ 3843 = $ 5242

This is same as that reported in schedule of long term debt in 10-K report

Scheduled maturities

($ Million)

April 2013

601

September 2013

500

April 2014 (500+300+400)

1200

September 2015

702

April 2016

402

April 2018

502

June 2019

604

April 2021

398

April 2028

379

April 2038

400

September 2040

300

The scheduled maturities provide an idea of the future cash outflows on account of coupon payments and terminal payments on maturity. This provides a part of the estimated cash flows for valuation of business.

Answer (b)

Reported interest payment $ 270 Million in notes to Income statement. Notes to the statement of cash flows interests portion reported as $279 Million.

This happens because of the accrued interest which was not paid in cash in the previous period. Costs in financial statements are calculated based on the accrual basis. That is those which are due for the period but were not paid during the accounting period. This will be shown as a provision and the payment is made by debit to the provisions. Cash flow statement accounts for the actual cash payments happened during the accounting period which results in this difference.

Answer (c)

Rating of Long Term Debt of Dell

Moody’s - Baa1+

S&P - BBB+

Fitch - BBB+

Credit rating provides a measure provided by a Rating Agency about the ability of the Debtor’s ability to pay back the debt and the likelihood of default. They are basically opinion of the credit rating agency concerned about the credit risk. This is done by evaluating various qualitative and quantitative information of the company. The measure is basically a measure of the probability of default of the particular bond issue over a time horizon. The factors used in arriving at a credit score and affecting the rating include

Answer (d)

Price of $300 Million bonds as on November 2013 = 69.50% of Par Value or $ 69.50. That is the Par value of the bond = $ 100

Total No of Bonds issued = $300 Million / $100 = 3 Million

Market Value of these bonds = 3 Million * 69.50 =$ 208.50 Million

The difference between the market value and face value does not get reflected in the financial statements of company. This is because the long term debt is shown at the level of actual indebtedness and not on the current market price of the bonds. Repurchase of the entire bonds will result in lowering the total indebtedness of the company. It reduces the cash flows to the extent of amount utilised for reduction. It further increases the capacity to contract further debt in future.

The bond is quoting at $ 69.50 vis-à-vis face value of $100. That is the bond is getting sold at a discount to face value. This indicates the interest rates in the economy have gone up since the bond issue. The price of the bond is a sum of the present values of coupon payments plus the present value of terminal cash flow. If the interest rates have gone up since the bond issue, an investor has a choice of investment in this bond or the one which is providing a higher coupon payment. Naturally he will prefer for the one giving the one giving higher coupon (for the same required rate of return for investor or YTM). In order to invest in the bond with a lower coupon payment, he needs an incentive in the form of a discount / reduction in price to the extent of the difference in yield between coupon of this bond and coupon of a similar bond with a higher interst.

Answer (e)

Given

Dell 5.4 Maturity - September 2040 YTM – 8.24%

Dell 6.5% Maturity – April 2038 YTM – 8.77%

Dell 4.625% Maturity – April 2021 YTM - 6.07%

Yield to maturity of a bond is the total anticipated annual return on a bond if held till maturity. This is calculated taking the present values of coupon payments and present value of the terminal cash flow of face value. This is equal to r in the following equation

Market Price = Coupon Payment * {1-1/(1+r)^n}/r + Par Value /(1+r)^n

Where n is the time to maturity (multiplied by no of coupon payments in a year in case of less than annual coupon payments)

From the above equation, it can be observed that the yield to maturity is dependent on the following factors