Including debt in the capital structure of companies such as Ceres Power Holdings plc (LON:CWR), which has no debt, can improve its capital returns as the cost of capital comes down. The debt is less costly due to relatively less risk born by debt-holders in the event of liquidation. Additionally, interest on debt reduces the tax liability.
A lower cost of capital increases a company’s valuation as it is the discount rate applied on future cash flows to calculate the present value; thus, indicating higher capital returns. Precisely due to the same reason, companies raised debt in their capital structure with costs at record lows in a low interest rate environment. This improved their capital returns and they were rewarded with higher valuations.
On the other hand, rate hikes are imminent, it’s a part of the broader economic cycle. No-debt companies will clearly be in a stronger cash position compared to companies of which most, if not all, will be forced to retire a chunk of their debt due to rising costs. Higher the interest rates, higher the cost of debt. Although zero-debt makes Ceres Power Holdings’s financial strength analysis lot more stressful, there are other metrics to check its financial health. Here’s a small checklist which I believe provides a ballpark estimate of their financial health status…
