Page 110 - Five Forces of Americanisation Richard Hooke 04072025 final post SDR1

The UK Defence Industry in the 21 Century
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The Five Forces of Americanisation

capital markets proved highly significant for corporates lacking liquidity during the financial crisis. As
then, bond markets are currently becoming both a popular source of debt and an appealing investment
proposition as market volatility increases with each announcement from the US government on tariffs,
trade and economic policy. Bonds with a seven-year tenor offer a reasonable level of certainty during
a period of rapid and dramatic change in market conditions.
The post tax cost of debt is represented by the following :
Cost of debt = (Risk free rate + Debt risk premium) x (1 - Tax rate)

A hypothetical example is as follows:
Eg: US Defco
6.04% = (4.35%* + 3.20%**) x (1 - 0.20***)

*The Risk free rate is again the yield on a ten-year US Treasury bond
**The Debt risk premium is the excess return required by debt holders to compensate for the higher risk
of holding corporate debt compared with risk-free securities. Credit ratings are based on rating
conversions published by ratings agencies such as Moody’s and S&P and by investment banks.
*** Author’s assumption
(A note of caution: at the start of 2025, US trade policy has increased the volatility of all market data
worldwide. The above data points should be treated as hypothetical)

3. Gearing will determine the weighting of equity in the WACC calculation. It is a crucial factor because
the cost of debt is often significantly lower (due to lower risk and the benefit of tax relief) than the cost
of equity.

However, major changes to gearing may impact the company’s beta and therefore affect the cost of
equity. This reflects the emphasis placed upon the robustness of a company’s Financial Policy by credit
ratings agencies.
Gearing (or “leverage”) is a crucial factor in the oversight of those companies in the private sector that
manage critical public utilities and services like water, energy, communications, healthcare, public
transport and defence, for example.
The Cost of Capital is the expected return on assets (or, similarly, all capital employed). This can be estimated
as a weighted average expected return on all sources of funding.
WACC = Kd x ( D/V ) + Ke x ( E/V )

A hypothetical example is as follows, where D, E, and V are the market values of Debt, Common
Equity and the total sum of these components (“Value”)

Eg: US Defco
++
++
8.83% = 6.04%* x ($462.22 / $1,287.77 ) + 10.40%** x ($825.55 / $1,287.77 )
*Kd is the expected cost of debt
**Ke is the expected cost of common equity
**The Debt risk premium is the excess return required by debt holders to compensate for the higher risk
of holding corporate debt compared with risk-free securities. Credit ratings are based on rating
conversions published by ratings agencies such as Moody’s and S&P and by investment banks.
++ D,V, E and V are the author’s assumptions: D = Net debt of $462.22m; E = Market value of basic

equity of $825.55; V = Enterprise value of $1,287.77m (ie: D + E)
Investors understand that increasing the amount of debt will lower the overall cost of capital. However, unlike
equity or shares, debt is not risk capital: it needs to be repaid and its price reflects this. Lenders will naturally
oppose cash distributions to shareholders while debt is imprudently high. However, when the lender is also a
shareholder, receiving dividends could be more efficient way of extracting value from a company.

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07/07/2025 Richard Hooke 2025