You are analyzing the leverage
January 18th, 2023
You are analyzing the leverage of two firms and you note thefollowing (all values in millions of dollars):
|
Debt |
Book Equity |
Market Equity |
Operating Income |
Interest Expense |
|
|
Firm A |
500.9 |
304.4 |
396.3 |
98.5 |
49.2 |
|
Firm B |
80.7 |
33.1 |
39.9 |
8.5 |
7.1 |
a. What is the market debt-to-equity ratio of each firm?
b. What is the book debt-to-equity ratio of each firm?
c. What is the interest coverage ratio of each firm?
d. Which firm will have more difficulty meeting its debtobligations?
Answer:
| Debt | Book equity | Market equity | Operating income | Interest expense | |||||
| Firm A | 500.9 | 304.4 | 396.3 | 98.5 | 49.2 | ||||
| Firm B | 80.7 | 33.1 | 39.9 | 8.5 | 7.1 | ||||
| Answer a | |||||||||
| Market debt to equity | = | Total debt / (total debt + market value of equity) | |||||||
| Firm A | = | 500.9/(500.9+396.3) | |||||||
| = | 0.56 | ||||||||
| Firm B | = | 80.7/(80.7+39.9) | |||||||
| = | 0.67 | ||||||||
| Answer b | |||||||||
| Book debt to equity | = | Total debt / Book equity | |||||||
| Firm A | = | 500.9/304.4 | |||||||
| = | 1.65 | ||||||||
| Firm B | = | 50.7/33.1 | |||||||
| = | 1.53 | ||||||||
| Answer c | |||||||||
| Interest coverage ratio | = | EBIT or Operating income / Interest | |||||||
| Firm A | = | 98.5/49.2 | |||||||
| = | 2.00 | ||||||||
| Firm B | = | 8.5/7.1 | |||||||
| = | 1.20 | ||||||||
| Answer d | |||||||||
| Firm B will have more difficulty in meeting its debtobligations as interest coverage ratio of firm B is lesser thanthat of Firm A |
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