3.1·7 min read

Paying Down Debt

Cash the business throws off after interest and reinvestment sweeps against the debt, lowering the balance each year.

By the end you can

✓Roll a debt balance forward
✓Use free cash flow to reduce debt

\text{Ending Debt} = \text{Beginning Debt} - \text{Free Cash Flow Swept}

A 'cash sweep' uses available free cash flow to repay debt ahead of schedule.

Worked example · Three years of paydown

Given

•Entry debt $500. Free cash flow available for debt: $80, $90, $100.

Solution

1.After year 1
$500 - 80 = 420$
2.After year 2
$420 - 90 = 330$
3.After year 3
$330 - 100 = 230$

Answer

Debt falls from $500 to $230 over three years - $270 of that accrues entirely to equity.

Interest follows the balance

Interest each year is the rate times the debt balance, so as debt falls, interest falls, freeing even more cash to repay debt - a virtuous cycle (the mirror image of the revolver's vicious one).

Check yourself

Beginning debt is $400 and $120 of free cash flow is swept. Ending debt is:

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Sizing the Debt

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Why Deleveraging Builds Equity