OceanDrillingKey Nov Nov (1)

7/28/2019 OceanDrillingKey Nov Nov (1)

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Ocean Drilling, Inc.


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Competing Bids

France (in FRF)

96M USD (534.72M FRF)

24M USD Down Pmt (72MUSD (75%) Financed)

10 1/2% APR

8 Year Term

Equal Annual PrinciplePayments

Japan (in JPY)

90M USD (20,443.5M JPY)

18 M USD Down Pmt (72MUSD (80%) Financed)

8 3/4% APR

10-Year Term

Equal Annual Principle

Payments


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Differential Cash Flows

Down Payment

Depreciation Tax Shield

Below Market Loan Payments

Tax Effects of Loan Amortization


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USD

FRF or JPY

Now Future

Down Payment

Depreciation

Tax Shield

Below Market

Loan Payments

Tax Effects of

Loan Amortization

Cash Flow Diagram


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Down Payment

Occurs now at time 0, so there is no discounting

Occurs in FRF or JPY, but USD can be converted

to FRF or JPY at spot market rates France down payment = 24M USD

Japan down payment = 18M USD

Difference is 6M USD, to Japans advantage


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USD

FRF or JPY

Now Future

Down Payment

Depreciation

Tax Shield

Below Market

Loan Payments

Tax Effects of

Loan Amortization

Cash Flow Diagram


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USD Discount Rate

WACC used to evaluate project: reflects

risks of project operating cash flows

Cost of debt used to evaluate debt

financing: reflects risks of debt-related cash

flows

? Before-Tax Cost of Debt = 20%

? After-Tax Cost of Debt = 10%

Assume Marginal Tax Rate = 50%


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Depreciation Tax Shield - France

5-Year Depreciation: 15M, 21M, 20M,

20M, 20M

Total = 96M

Depreciation Tax Shield: 7.5M, 10.5M,

10M, 10M, 10M

NPV @ 20% = 28.17M

NPV @ 10% = 36.05M


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Depreciation Tax Shield - Japan

5-Year Depreciation: 13M, 20M, 19M,

19M, 19M

Total = 90M

Depreciation Tax Shield: 6.5M, 10M, 9.5M,

9.5M, 9.5M

NPV @ 20% = 26.26M

NPV @ 10% = 33.70M


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Depreciation Tax Shield

@ 20% discount rate, difference is 1.91M

USD, to Frances advantage


USD, to Frances advantage

The more expensive the equipment, the

more valuable the depreciation tax shield


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USD

FRF or JPY

Now Future

Down Payment

Depreciation

Tax Shield

Below Market

Loan PaymentsTax Effects of

Loan Amortization

Cash Flow Diagram


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Loan Payments - FRF

Time Total Price Down Payment Loan Principle Beginning Interest After-Tax Net

Payments Balance Interest Cash Flow

0 535.68 133.92 401.76 0

1 -50.22 401.76 42.18 21.09 -71.31

2 -50.22 351.54 36.91 18.46 -68.68

3 -50.22 301.32 31.64 15.82 -66.04

4 -50.22 251.1 26.37 13.18 -63.40

5 -50.22 200.88 21.09 10.55 -60.77

6 -50.22 150.66 15.82 7.91 -58.13

7 -50.22 100.44 10.55 5.27 -55.49

8 -50.22 50.22 5.27 2.64 -52.86


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Loan Payments - JPY

Time Total Price Down Payment Loan Principle Beginning Interest After-Tax Net

Payments Balance Interest Cash Flow

0 20457 4091.4 16366 0

1 -1636.56 16365.60 1431.99 716.00 -2352.56

2 -1636.56 14729.04 1288.79 644.40 -2280.96

3 -1636.56 13092.48 1145.59 572.80 -2209.36

4 -1636.56 11455.92 1002.39 501.20 -2137.76

5 -1636.56 9819.36 859.19 429.60 -2066.16

6 -1636.56 8182.80 716.00 358.00 -1994.56

7 -1636.56 6546.24 572.80 286.40 -1922.96

8 -1636.56 4909.68 429.60 214.80 -1851.36

9 -1636.56 3273.12 286.40 143.20 -1779.76

10 -1636.56 1636.56 143.20 71.60 -1708.16


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Expected Spot Rates

Forward Rates - Forward Parity

Interest Rates - International Fisher Effect

Expected Inflation Rates - Purchasing

Power Parity

Other


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Forward RatesTime FRF JPY

Spot 5.570/80 227.15/227.30

Midpoint 5.575 227.225

6-Month Midpoint 5.6775 219.9500

Premium/(Discount) -3.61% 6.62%

12-Month Midpoint 5.7800 212.4000


2-Year Midpoint 6.0300 197.2500


5-Year Midpoint No Quote 184.1500

Premium/(Discount) 4.68%


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Interest Rate-Based ForecastsUSD FRF JPY

Long-Term 0.161 0.179 0.109

Interest Rates

Factor 1.01550388 0.95521102

Spot 5.5750 227.2250

1 5.6615 217.0478

2 5.7493 207.3265

3 5.8385 198.0405

4 5.9291 189.17055 6.0211 180.6977

6 6.1145 172.6045

7 6.2093 164.8737

8 6.3057 157.4892

9 6.4035 150.4354

10 6.5028 143.6975


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Expected USD Loan Payments:

France LoanTime Net FRF Forecast Net USD

Cash Flow Spot Rate Cash Flow

0 72.00

1 -71.31 5.66 -12.60

2 -68.68 5.75 -11.95

3 -66.04 5.84 -11.31

4 -63.40 5.93 -10.695 -60.77 6.02 -10.09

6 -58.13 6.11 -9.51

7 -55.49 6.21 -8.94

8 -52.86 6.31 -8.38


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Expected USD Loan Payments:

Japan LoanTime Net JPY Forecast Net USDCash Flow Spot Rate Cash Flow

0 72.00

1 -2352.56 217.05 -10.84

2 -2280.96 207.33 -11.00

3 -2209.36 198.04 -11.16

4 -2137.76 189.17 -11.30

5 -2066.16 180.70 -11.436 -1994.56 172.60 -11.56

7 -1922.96 164.87 -11.66

8 -1851.36 157.49 -11.76

9 -1779.76 150.44 -11.83

10 -1708.16 143.70 -11.89


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Value of Discount FinancingTime Net USD Net USD

Cash Flow Cash Flow

FRF Loan JPY Loan

0 72.00 72.00

1 -12.60 -10.84

2 -11.95 -11.00

3 -11.31 -11.16

4 -10.69 -11.30

5 -10.09 -11.43

6 -9.51 -11.56

7 -8.94 -11.66

8 -8.38 -11.76

9 -11.8310 -11.89

Discount Rate 20% 20%

NPV 29.82 24.75


NPV 14.75 2.26


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Discount Financing

@ 20% discount rate, difference is 5.07M USD, toFrances advantage

@ 10% discount rate, difference is 12.48M USD,to Frances advantage

The greater the difference between the market rateand the loan rate, the greater the value of the

discount financing: France = 7.4% (17.9%-10.5%); Japan = 2.15% (10.9% - 8.75%)

The higher the discount rate, the smaller the valueof the payments compared to the amount

borrowed


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USD

FRF or JPY

Now Future

Down Payment

Depreciation

Tax Shield

Below Market

Loan PaymentsTax Effects of

Loan Amortization

Cash Flow Diagram


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Loan Amortization

The USD value of the loan will decline by the

same amount each year on the balance sheet

The amount by which the loan declines will not beequal to the cash required to make the loan

payment: the FRF loan will require fewer USD

each year and the JPY loan will require more USD

each year

The gain (on the FRF loan) is taxable, and the loss

(on the JPY loan) provides a tax shield.


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Loan Amortization: France

Time Loan Loan Principle Expected Loan Principle Foreign Exchange Tax Effect

Amortization Payment Spot Rates Payment Gain/Loss

USD FRF USD USD USD

0 0.00 0.00 5.5750

1 -9.00 -50.22 5.6615 -8.87 0.13 0.062 -9.00 -50.22 5.7493 -8.73 0.27 0.13

3 -9.00 -50.22 5.8385 -8.60 0.40 0.20

4 -9.00 -50.22 5.9291 -8.47 0.53 0.26

5 -9.00 -50.22 6.0211 -8.34 0.66 0.33

6 -9.00 -50.22 6.1145 -8.21 0.79 0.39

7 -9.00 -50.22 6.2093 -8.09 0.91 0.46

8 -9.00 -50.22 6.3057 -7.96 1.04 0.52


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Loan Amortization: Japan

Time Loan Loan Principle Expected Loan Principle Foreign Exchange Tax Effect

Amortization Payment Spot Rates Payment Gain/Loss

USD FRF USD USD USD

0 0.00 0.00 227.2250

1 -7.20 -1636.56 217.0478 -7.54 -0.34 -0.17

2 -7.20 -1636.56 207.3265 -7.89 -0.69 -0.353 -7.20 -1636.56 198.0405 -8.26 -1.06 -0.53

4 -7.20 -1636.56 189.1705 -8.65 -1.45 -0.73

5 -7.20 -1636.56 180.6977 -9.06 -1.86 -0.93

6 -7.20 -1636.56 172.6045 -9.48 -2.28 -1.14

7 -7.20 -1636.56 164.8737 -9.93 -2.73 -1.36

8 -7.20 -1636.56 157.4892 -10.39 -3.19 -1.60

9 -7.20 -1636.56 150.4354 -10.88 -3.68 -1.84

10 -7.20 -1636.56 143.6975 -11.39 -4.19 -2.09


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Tax Effect of Loan AmortizationTime Net USD Net USD

Cash Flow Cash Flow

FRF Loan JPY Loan

0

1 0.06 -0.17

2 0.13 -0.35

3 0.20 -0.53

4 0.26 -0.73

5 0.33 -0.93

6 0.39 -1.14

7 0.46 -1.36

8 0.52 -1.60

9 -1.8410 -2.09


NPV 0.90 (3.24)


NPV 1.40 (5.59)


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Tax Effect of Loan Amortization


USD, to Japans advantage

@ 10% discount rate, difference is 6.99MUSD, to Japans advantage

The stronger the foreign currency, the more

valuable the tax effect of loan amortization


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Net Differential Value>0: Advantage to France


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20% or 10% Discount Rate?

There are two benefits to below-market financing: reducedafter-tax interest and increased debt capacity

If the company can realize both benefits, the after-tax cost

of debt (10%) is the appropriate discount rate If the company can not take advantage of the increased

debt capacity (as for Ocean Drilling), the before tax cost ofdebt (20%) is the appropriate discount rate

With the shipyard financing, Ocean Drillings ratio ofsenior debt to the sum of subordinated debt plusshareholders equity will be 1.28 ((240+72)/(50+194)).Their loan covenant requires it to be less than 1.25.


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Financial Summary

The terms of the Japanese loan look better

The Japanese loan is 3.16M USD better

than the French loan using the correct 20%(before-tax cost of debt) discount rate

The French loan is 1.84M USD better than

the Japanese loan using the more familiar10% (after-tax cost of debt) discount rate


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Practical Considerations

The difference between the loans is at best

3.5% (3.16M/90M) of the purchase price if

purchased in Japan (and only 1.9%(1.84M/96M) of the purchase price if

purchased in France)

Because these differences are based onuncertain estimates of future exchange

rates, they are not financially significant


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Hedging

The firm faces substantial operating risk;therefore, it should attempt to reduce financial risk

Forward Hedge: FRF forward rates are availablefor only 2 years (25% of the life of the loan) andJPY forward rates are available for only 5 years(50% of the life of the loan)

Money Market Hedge: Ocean Drilling does nothave the debt capacity to use a money markethedge

Swap: The appropriate hedging tool


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Documents

OceanDrillingKey Nov Nov (1)