There are certain situations where the fair market value of a note can be less than the face value. For example, if Company A holds a note receivable from Company B, and Company B has demonstrated financial hardship or inability to repay the note, then the value of the note is potentially impaired.
One approach to determining the value of the note would be to value the expected cash flow from the note using an appropriate discount rate. Determining the right discount rate requires specialized expertise and is subjective. The following risk-return attributes should be considered in the note valuation: creditworthiness of the creditor, default provisions, security, liquidity, payment history, interest rate, term and size of the note. Also, the debtor’s financial history and outlook should be considered as well in determining the proper rate to apply to the expected cash flow from the note.
The return on corporate bonds can be a good source to assist in determining an appropriate discount rate. Corporate bonds are rated based on the financial condition and creditworthiness of the company repaying the bonds. Credit rating agencies such as Moody’s Investor Service and Standard & Poor’s publish the rating of corporate bonds. The debtor’s financial condition and other factors can be compared to the companies issuing the corporate bonds to help select an appropriate bond return rate to use as a basis for the discount rate to value the note from the debtor.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.