Part 2 TKM0844 11E IM Ch15
Chapter 15
Capital Structure Policy
15-1.
A. We can calculate Webb’s debt ratio using equation 15-1:
total liabilities debt ratio =
.
total assets
Webb’s total debt includes both its current liabilities of $750,000 and its long-term debt of
$750,000. Webb’s total debt is therefore $1,500,000. Its total assets, which equal the total of its debt and owners’ equity, equal $2,000,000. The firm’s debt ratio is therefore:
$1,500,000 debt ratio =
= 75%.
$2,000,000
Using its book values, then, Webb appears heavily debt-financed, funding 75% of its assets with debt.
The debt ratio includes all of Webb’s debt, and is a reflection of the firm’s financial structure.
If instead we were to focus only on its interest-bearing debt, then we would omit accounts payable from the ratio’s numerator, giving us the interest-bearing debt ratio:
$1,000,000 interest-bearing debt ratio =
= 50%.
$2,000,000
(This is a measure of the firm’s capital structure.) Omitting Webb’s $500,000 in A/P decreases the relevant proportion of debt to assets from 75% to 50%.
B. If we were interested in Webb’s debt-to-value ratio, we would need to find the ratio of the market value of Webb’s interest-bearing debt to the sum of the market values of both its interest-bearing debt and equity: debt-to-value ratio =
TMVdebt
,
(TMVdebt + TMVequity )
where the debt is the interest-bearing debt. (Note that equation 15-2 expresses the debt values as book values, noting that they are approximating the market values. Debt’s relative illiquidity makes it more difficult to find market values for a firm’s debt than for its equity.)
We are told that Webb’s debt’s market value is the same as its book value. Since we’re using only the interest-bearing debt, this means that TMVint-bearing debt = $1M. Thus, its debt-to-value ratio is: debt-to-value ratio =
$1,000,000
= 33.33%.
($1,000,000 + $2,000,000)
©2011 Pearson Education, Inc. Publishing as Prentice Hall
400
Titman/Keown/Martin
Capital Structure Policy
15-1.
A. We can calculate Webb’s debt ratio using equation 15-1:
total liabilities debt ratio =
.
total assets
Webb’s total debt includes both its current liabilities of $750,000 and its long-term debt of
$750,000. Webb’s total debt is therefore $1,500,000. Its total assets, which equal the total of its debt and owners’ equity, equal $2,000,000. The firm’s debt ratio is therefore:
$1,500,000 debt ratio =
= 75%.
$2,000,000
Using its book values, then, Webb appears heavily debt-financed, funding 75% of its assets with debt.
The debt ratio includes all of Webb’s debt, and is a reflection of the firm’s financial structure.
If instead we were to focus only on its interest-bearing debt, then we would omit accounts payable from the ratio’s numerator, giving us the interest-bearing debt ratio:
$1,000,000 interest-bearing debt ratio =
= 50%.
$2,000,000
(This is a measure of the firm’s capital structure.) Omitting Webb’s $500,000 in A/P decreases the relevant proportion of debt to assets from 75% to 50%.
B. If we were interested in Webb’s debt-to-value ratio, we would need to find the ratio of the market value of Webb’s interest-bearing debt to the sum of the market values of both its interest-bearing debt and equity: debt-to-value ratio =
TMVdebt
,
(TMVdebt + TMVequity )
where the debt is the interest-bearing debt. (Note that equation 15-2 expresses the debt values as book values, noting that they are approximating the market values. Debt’s relative illiquidity makes it more difficult to find market values for a firm’s debt than for its equity.)
We are told that Webb’s debt’s market value is the same as its book value. Since we’re using only the interest-bearing debt, this means that TMVint-bearing debt = $1M. Thus, its debt-to-value ratio is: debt-to-value ratio =
$1,000,000
= 33.33%.
($1,000,000 + $2,000,000)
©2011 Pearson Education, Inc. Publishing as Prentice Hall
400
Titman/Keown/Martin