Ratings: Critical Analysis and New Approaches of Quantitative and Qualitative Methodology

Preface
Contents
About the Authors
Chapter 1: Introduction
	1.1 Monograph Structure
	References
Chapter 2: The Importance of Rating and the Disadvantages of Existing Rating Systems
	2.1 The Importance of Rating
	2.2 The Analysis of Methodological and Systemic Deficiencies in the Existing Credit Rating of Non-Financial Issuers
		2.2.1 The Closeness of the Rating Agencies
		2.2.2 Discounting
		2.2.3 Dividend Policy of the Company
		2.2.4 Leverage Level
		2.2.5 Taxation
		2.2.6 Accounting of the Industrial Specifics of the Issuer
		2.2.7 Neglect of Taking into Account the Particularities of the Issuer
		2.2.8 Financial Ratios
	References
Part I: Corporate Finance Theories Used in Ratings and in Rating Methodologies
	Chapter 3: Capital Structure: Modigliani-Miller Theory
		3.1 Introduction
		3.2 The Traditional Approach
		3.3 Modigliani-Miller Theory
			3.3.1 Modigliani-Miller Theory Without Taxes
			3.3.2 Modigliani-Miller Theory with Taxes
			3.3.3 Main Assumptions of Modigliani-Miller Theory
			3.3.4 Modifications of Modigliani-Miller Theory
		References
	Chapter 4: Modification of the Modigliani-Miller Theory for the Case of Advance Tax on Profit Payments
		4.1 Introduction
		4.2 Modified Modigliani-Miller Theory in Case of Advance Tax Payments
			4.2.1 Tax Shield in Case of Advance Tax Payments
			4.2.2 Capitalization of the Company
			4.2.3 Equity Cost
		4.3 The Dependence of the Weighted Average Cost of Capital, WACC, on Leverage Level in the ``Classical´´ Modigliani-Miller The...
		4.4 Conclusions
		References
	Chapter 5: Modern Theory of Capital Cost and Capital Structure: Brusov-Filatova-Orekhova Theory (BFO Theory)
		5.1 Companies of Arbitrary Age and Companies with Arbitrary Lifetime: Brusov-Filatova-Orekhova Equation
			5.1.1 Algorithm for Finding WACC in the Case of Companies of Arbitrary Age
		5.2 Comparison of Modigliani-Miller Results (Perpetuity Company) with Myers Results (1-Year Company) and Brusov-Filatova-Orekh...
			5.2.1 Discussion of Results
		5.3 Brusov-Filatova-Orekhova Theorem
			5.3.1 Case of Absence of Corporate Taxes
			5.3.2 Case of the Presence of Corporate Taxes
		5.4 From Modigliani-Miller to General Theory of Capital Cost and Capital Structure
			5.4.1 Tax Shield
		5.5 BFO Theory in the Case, When the Company Ceased to Exist at the Time Moment n (BFO-2 Theory)
			5.5.1 Application of Formula BFO-2
			5.5.2 Comparison of Results Obtained from Formulas BFO and BFO-2
		References
Part II: Ratings and Rating Methodologies of Non-financial Issuers
	Chapter 6: Application of the Modigliani-Miller Theory in Rating Methodology
		6.1 Introduction
		6.2 The Closeness of the Rating Agencies
		6.3 The Use of Discounting in the Rating
		6.4 Incorporation of Parameters, Using in Ratings, into Perpetuity Limit of Modern Theory of Capital Structure by Brusov-Filat...
		6.5 Models
			6.5.1 One-Period Model
			6.5.2 Multi-Period Model
		6.6 Theory of Incorporation of Parameters, Using in Ratings, into Perpetuity Limit of Modern Theory of Capital Structure by Br...
			6.6.1 Coverage Ratios
				6.6.1.1 Coverage Ratios of Debt
				6.6.1.2 Coverage Ratios of Interest on the Credit
				6.6.1.3 Coverage Ratios of Debt and Interest on the Credit (New Ratios)
			6.6.2 More Detailed Consideration
			6.6.3 Leverage Ratios
				6.6.3.1 Leverage Ratios for Debt
				6.6.3.2 Leverage Ratios for Interest on Credit
				6.6.3.3 Leverage Ratios for Debt and Interest on Credit
		6.7 Equity Cost
			6.7.1 The Dependence of Equity cost ke on Coverage Ratios i1, i2, i3
			6.7.2 The Dependence of Equity Cost ke on Leverage Ratios l1, l2, l3
			6.7.3 The Dependence of Equity Cost ke on Leverage Ratio l1
			6.7.4 The Dependence of Equity Cost ke on Leverage Ratios l2
			6.7.5 The Dependence of Equity Cost ke on Leverage Ratios l3
		6.8 How to Evaluate the Discount Rate?
			6.8.1 Using One Ratio
			6.8.2 Using a Few Ratios
		6.9 Influence of Leverage Level
			6.9.1 The Dependence of Equity Cost ke on Leverage Level at Two Coverage Ratio Values ij = 1 and ij = 2
		6.10 The Dependence of Equity Cost ke on Leverage Level at Two Leverage Ratio Values lj = 1 and lj = 2
		6.11 Conclusion
		References
	Chapter 7: Application of the Modigliani-Miller Theory, Modified for the Case of Advance Payments of Tax on Profit, in Rating ...
		7.1 Introduction
		7.2 odified Modigliani-Miller Theory
			7.2.1 Tax Shield
			7.2.2 The Weighted Average Cost of Capital (WACC)
		7.3 Application of Modified of Modigliani-Miller Theory for Rating Needs
			7.3.1 Coverage Ratios
				7.3.1.1 Coverage Ratios of Debt
				7.3.1.2 Coverage Ratios of Interest on the Credit
				7.3.1.3 Coverage Ratios of Debt and Interest on the Credit
			7.3.2 Dependence of WACC on Leverage Ratios of Debt in the ``Classical´´ Modigliani-Miller Theory (MM theory) and Modified Mod...
			7.3.3 Leverage Ratios
				7.3.3.1 Leverage Ratios for Debt
				7.3.3.2 Leverage Ratios for Interest on Credit
				7.3.3.3 Leverage Ratios for Debt and Interest on Credit
				7.3.3.4 Dependence of WACC on Leverage Ratios of Debt in the ``Classical´´ Modigliani-Miller Theory (MM Theory) and Modified M...
		7.4 Discussions
		References
	Chapter 8: Application of Brusov-Filatova-Orekhova Theory (BFO Theory) in Rating Methodology
		8.1 Introduction
			8.1.1 Modification of the BFO Theory for Companies and Corporations of Arbitrary Age for the Purposes of Ranking
				8.1.1.1 Coverage Ratios
				8.1.1.2 Coverage Ratios of Debt
				8.1.1.3 The Coverage Ratio on Interest on the Credit
				8.1.1.4 Coverage Ratios of Debt and Interest on the Credit (New Ratios)
				8.1.1.5 All Three Coverage Ratios Together
			8.1.2 Coverage Ratios (Different Capital Cost Values)
				8.1.2.1 Coverage Ratios of Debt
				8.1.2.2 The Coverage Ratio on Interest on the Credit
				8.1.2.3 Coverage Ratios of Debt and Interest on the Credit (New Ratios)
				8.1.2.4 Analysis and Conclusions
			8.1.3 Leverage Ratios
				8.1.3.1 Leverage Ratios for Debt
				8.1.3.2 Leverage Ratios for Interest on Credit
			8.1.4 Leverage Ratios (Different Capital Costs)
				8.1.4.1 Leverage Ratios for Debt
				8.1.4.2 Leverage Ratios for Interests on Credit
				8.1.4.3 Leverage Ratios for Debt and Interests on Credit
				8.1.4.4 Analysis and Conclusions
		8.2 Conclusions
		References
Part III: Project Ratings
	Chapter 9: Investment Models with Debt Repayment at the End of the Project and their Application
		9.1 Investment Models
		9.2 The Effectiveness of the Investment Project from the Perspective of the Equity Holders Only
			9.2.1 With the Division of Credit and Investment Flows
				9.2.1.1 Projects of Finite (Arbitrary) Duration
				9.2.1.2 At a Constant Value of the Invested Capital (I = const)
				9.2.1.3 For 1-Year Project
				9.2.1.4 At a Constant Value of Equity Capital (S = const)
				9.2.1.5 For 1-Year Project
		9.3 Without Flows Separation
		9.4 Modigliani-Miller Limit (Perpetuity Projects)
			9.4.1 With Flows Separation
				9.4.1.1 At a Constant Value of the Invested Capital (I = const)
				9.4.1.2 At a Constant Value of Equity Capital (S = const)
			9.4.2 Without Flows Separation
				9.4.2.1 At a Constant Value of the Invested Capital (I = const)
				9.4.2.2 At a Constant Value of Equity Capital (S = const)
		9.5 The Effectiveness of the Investment Project from the Perspective of the Owners of Equity and Debt
			9.5.1 With Flows Separation
				9.5.1.1 Projects of Arbitrary (Finite) Duration
				9.5.1.2 At a Constant Value of the Invested Capital (I = const)
				9.5.1.3 At a Constant Value of Equity Capital (S = const)
				9.5.1.4 For 1-Year Project
			9.5.2 Without Flows Separation
				9.5.2.1 At a Constant Value of the Invested Capital (I = const)
				9.5.2.2 For 1-Year Project
				9.5.2.3 At a Constant Value of Equity Capital (S = const)
				9.5.2.4 For 1-Year Project
		9.6 Modigliani-Miller Limit
			9.6.1 With Flows Separation
				9.6.1.1 At a Constant Value of Equity Capital (S = const)
			9.6.2 Without Flows Separation
				9.6.2.1 At a Constant Value of Equity Capital (S = const)
		References
	Chapter 10: Investment Models with Uniform Debt Repayment and Their Application
		10.1 Investment Models with Uniform Debt Repayment
		10.2 The Effectiveness of the Investment Project from the Perspective of the Equity Holders Only
			10.2.1 With the Division of Credit and Investment Flows
			10.2.2 Without Flows Separation
		10.3 The Effectiveness of the Investment Project from the Perspective of the Owners of Equity and Debt
			10.3.1 With Flows Separation
			10.3.2 Without Flows Separation
		10.4 Example of the Application of the Derived Formulas
		10.5 Conclusions
		References
	Chapter 11: A New Approach to Ratings of the Long-Term Projects
		11.1 Investment Models
			11.1.1 The Effectiveness of the Investment Project from the Perspective of the Equity Holders Only (Without Flows Separation)
			11.1.2 Modigliani-Miller Limit (Long--term (Perpetuity) Projects)
		11.2 Incorporation of Financial Coefficients, Used in Project Rating, into Modern Investment Models
			11.2.1 Coverage Ratios
				11.2.1.1 Coverage Ratios of Debt
				11.2.1.2 Coverage Ratios of Interest on the Credit
				11.2.1.3 Coverage Ratios of Debt and Interest on the Credit
			11.2.2 Leverage Ratios
				11.2.2.1 Leverage Ratios for Debt
				11.2.2.2 Leverage Ratios for Interest on Credit
				11.2.2.3 Leverage Ratios for Debt and Interest on Credit
		11.3 Dependence of NPV on Coverage Ratios
			11.3.1 Coverage Ratio on Debt
				11.3.1.1 The Dependence of NPV on Coverage Ratio on Debt i1 at Equity Cost k0 = 24%
				11.3.1.2 The Dependence of NPV on Coverage Ratio on Debt i1 at Equity Cost k0 = 12%
		11.4 Dependence of NPV on Leverage Ratios
			11.4.1 Leverage Ratio of Debt
				11.4.1.1 The Dependence of NPV (in Units of NOI) (NPV/NOI) on Leverage Ratio on Debt l1 at Equity Cost k0 = 0.12
				11.4.1.2 The Dependence of NPV (in Units of NOI) (NPV/NOI) on Leverage Ratio on Debt l1 at Equity Cost k0 = 0.14
				11.4.1.3 The Dependence of NPV (in Units of NOI) (NPV/NOI) on Leverage Ratio on Debt l1 at Equity Cost k0 = 0.26
		11.5 Conclusions
		References
	Chapter 12: Ratings of the Investment Projects of Arbitrary Durations: New Methodology
		12.1 Introduction
		12.2 Investment Models
			12.2.1 The Effectiveness of the Investment Project from the Perspective of the Equity Holders Only (Without Flows Separation)
		12.3 Incorporation of Financial Coefficients, Used in Project Rating, into Modern Investment Models, Describing the Investment...
			12.3.1 Coverage Ratios
				12.3.1.1 Coverage Ratios of Debt
				12.3.1.2 Coverage Ratios of Interest on the Credit
				12.3.1.3 Coverage Ratios of Debt and Interest on the Credit
			12.3.2 Leverage Ratios
				12.3.2.1 Leverage Ratios for Debt
				12.3.2.2 Leverage Ratios for Interest on Credit
				12.3.2.3 Leverage Ratios for Debt and Interest on Credit
		12.4 Results and Analysis
			12.4.1 Dependence of NPV/D on Coverage Ratios
				12.4.1.1 The Dependence of NPV on Coverage Ratio on Debt i1
				12.4.1.2 The Dependence of NPV on Leverage Ratio on Debt l1
				12.4.1.3 The Dependence of NPV on Coverage Ratio on Debt i1 at Different Values of kd
				12.4.1.4 The Dependence of NPV/NOI on Leverage Ratio on Debt l1 at Different Values of kd
		12.5 Conclusion
		References
	Chapter 13: Ratings of Investment Projects of Arbitrary Duration with a Uniform Debt Repayment: A New Approach
		13.1 Introduction
		13.2 Incorporation of Financial Ratios Used in Project Rating Into Modern Investment Models with Uniform Repayment of Debt
			13.2.1 Coverage Ratios
				13.2.1.1 Coverage Ratios of Debt
				13.2.1.2 Coverage Ratios of Interest on the Credit
				13.2.1.3 Coverage Ratios of Debt and Interest on the Credit (New Parameter)
			13.2.2 Leverage Ratios
				13.2.2.1 Leverage Ratios for Debt
				13.2.2.2 Leverage Ratios for Interest on Credit
				13.2.2.3 Leverage Ratios for Debt and Interest on Credit
			13.2.3 Perpetuity Limit
			13.2.4 The Study of the Dependence of the Net Present Value of the Project, NPV, on Rating Parameters
				13.2.4.1 Investigation of the Dependence of the Net Present Value of the Project, NPV (in Units of Debt D) on Coverage Ratios
				13.2.4.2 Study of the Dependence of the Net Present Value of the Project NPV (in Units of Net Operating Income NOI) on Leverag...
		13.3 Conclusions
		References
Part IV: New Meaningful Effects in Modern Capital Structure Theory (BFO Theory) Which Should Be Accounting in Rating Methodolo...
	Chapter 14: The Golden Age of the Company (Three Colors of Company´s Time)
		14.1 Introduction
			14.1.1 Dependence of WACC on the Age of the Company n at Different Leverage Levels
			14.1.2 Dependence of WACC on the Age of the Company n at Different Values of Capital Costs (Equity, k0, and Debt, kd) and Fixe...
			14.1.3 Dependence of WACC on the Age of the Company n at Different Values of Debt Capital Cost, kd, and Fixed Equity Cost, k0,...
			14.1.4 Dependence of WACC on the Age of the Company n at Different Values of Equity Cost, k0, and Fixed Debt Capital Cost, kd,...
			14.1.5 Dependence of WACC on the Age of the Company n at High Values of Capital Cost (Equity, k0, and Debt, kd) and High Lifet...
				14.1.5.1 At Fixed Leverage Level
				14.1.5.2 Under Change of the Debt Capital Cost, kd
				14.1.5.3 Under Change of the Equity Capital Cost, k0 (Tables 14.31, 14.32, 14.33, 14.34, 14.35, and 14.36)
				14.1.5.4 Under Change of the Tax on Profit Rate, t (Tables 14.37 and 14.38)
			14.1.6 Further Investigation of Effect
		14.2 Conclusions
		References
	Chapter 15: A ``Silver Age´´ of the Companies. Conditions of Existence of ``Golden Age´´ and ``Silver Age´´ Effects
		15.1 Introduction
		15.2 Companies without the ``Golden Age´´ (Large Difference between k0 and kd Costs)
			15.2.1 Dependence of Weighted Average Cost of Capital, WACC, on the Company Age n at Different Leverage Levels
		15.3 Companies with the ``Golden Age´´ (Small Difference between k0 and kd Costs)
		15.4 Companies with Abnormal ``Golden Age´´ (Intermediate Difference between k0 and kd Costs)
		15.5 Comparing with Results from the Previous Chapter
			15.5.1 Under Change of the Debt Capital Cost, kd
			15.5.2 Under Change of the Equity Capital Cost, k0
		15.6 Conclusions
		References
	Chapter 16: Inflation in Brusov-Filatova-Orekhova Theory and in Its Perpetuity Limit-Modigliani-Miller Theory
		16.1 Introduction
			16.1.1 Accounting of Inflation in Modigliani-Miller Theory without Taxes
				16.1.1.1 Second Original MM Statement
				16.1.1.2 Second Modified MM-BFO Statement
			16.1.2 Accounting of Inflation in Modigliani-Miller Theory with Corporate Taxes
				16.1.2.1 Fourth Original MM Statement
				16.1.2.2 Fourth Modified MM-BFO Statement
			16.1.3 Accounting of Inflation in Brusov-Filatova-Orekhova Theory with Corporate Taxes
				16.1.3.1 Generalized Brusov-Filatova-Orekhova Theorem
					Generalized Brusov-Filatova-Orekhova Theorem
			16.1.4 Generalized Brusov-Filatova-Orekhova Formula Under Existence of Inflation
			16.1.5 Irregular Inflation
			16.1.6 Inflation Rate for a Few Periods
		16.2 Conclusions
		References
	Chapter 17: A Qualitatively New Effect in Corporate Finance: Abnormal Dependence of Equity Cost of Company on Leverage Level
		17.1 Introduction
			17.1.1 Equity Cost in the Modigliani-Miller Theory
				17.1.1.1 With the Increase of Financial Leverage
			17.1.2 Equity Cost Capital Within Brusov-Filatova-Orekhova Theory
				17.1.2.1 Dependence of Equity Cost ke on Tax on Profit Rate T at Different Fixed Leverage Levels L
				17.1.2.2 Dependence of Equity Cost ke on Leverage Level L (the Share of Debt Capital wd) at Different Fixed Tax on Profit Rate...
			17.1.3 Dependence of the Critical Value of Tax on Profit Rate T* on Parameters N,k0,kd of the Company
			17.1.4 Practical Value of Effect
			17.1.5 Equity Cost of 1-Year Company
		17.2 Finding a Formula for T*
		17.3 Conclusions
		References
	Chapter 18: The Impact of Taxing and Leverage in Evaluation of Capital Cost, Capitalization of the Company and Issued Ratings
		18.1 The Role of Taxes in Modigliani-Miller Theory
		18.2 The Role of Taxes in Brusov-Filatova-Orekhova Theory
			18.2.1 Weighted Average Cost of Capital of the Company WACC
				18.2.1.1 Dependence of Weighted Average Cost of Capital of the Company WACC on Tax on Profit Rate  at Fixed Leverage Level L
				18.2.1.2 Dependence of Weighted Average Cost of Capital of the Company WACC on Debt Capital Fraction wd at Fixed Tax on Profit...
				18.2.1.3 Dependence of Weighted Average Cost of Capital of the Company WACC on Leverage Level L at Fixed Tax on Profit Rate
			18.2.2 Equity Cost ke of the Company
				18.2.2.1 Dependence of Equity Cost ke of the Company on Tax on Profit Rate  at Fixed Leverage Level L
				18.2.2.2 Dependence of Equity Cost ke of the Company on Leverage Level L on Fixed Tax on Profit Rate
			18.2.3 Dependence of WACC and ke on the Age of Company
				18.2.3.1 Dependence of Weighted Average Cost of Capital of the Company WACC on Company Age at Different Fixed Tax on Profit Ra...
				18.2.3.2 Dependence of Weighted Average Cost of Capital of the Company WACC on the Company Age at Different Fixed Fractions of...
				18.2.3.3 Dependence of Equity Cost of the Company ke on the Company Age n at Different Fixed Fractions of Debt Capital wd
				18.2.3.4 Dependence of Equity Cost of the Company ke on Company Age n at Different Fixed Tax on Profit Rate T
		18.3 Conclusions
		References
	Chapter 19: Recommendations to International Rating Agencies (Big Three (Standard and Poor´s, Fitch, and Moody´s), European, a...
		19.1 Discounting and Discount Rates
		19.2 Dividend Policy of the Company
		19.3 Leverage Level
		19.4 Taxation
		19.5 Account of the Industrial Specifics of the Issuer
		19.6 Neglect of Taking into Account the Particularities of the Issuer
		19.7 Financial Ratios
		References
	Chapter 20: Conclusions
		References