Debt to Equity

RECENT NEWS
The Economic Times  Jan 9  Comment 
MBL is on a strong wicket: its balance sheet, with one of the lowest long-term debt to equity ratio of 1.5 gives it an edge.
Wall Street Journal  Dec 20  Comment 
Bumi Resources' attempt to reduce its debt burden stalls, as it fails to get enough shareholders to vote for a restructuring proposal; extraordinary meeting scheduled for Jan. 10.
SeekingAlpha  Dec 16  Comment 
By Muhammad Bazil: Times are tough financially all around and no company has gotten through without feeling the effects, but some companies are doing worse than others. Nokia (NOK) is one company that has definitely had a difficult time staying...
The Globe and Mail  Aug 22  Comment 
We screen for Canadian stocks with price-to-earnings ratios of less than 10 and debt-to-equity ratios of less than 50 per cent
The Hindu Business Line  May 3  Comment 
Debt-to-equity still higher than Idea Cellular and RCom
The Globe and Mail  Jan 18  Comment 
We look for TSX-listed stocks with P/Es of less than 10 and debt-to-equity ratios of less than 50 per cent
MarketWatch  Aug 29  Comment 
Some say that business should serve as a model for government, at least in terms of managing debt and finances. On the other hand, both the public and private sectors have their debt problems.
The Economic Times  Aug 16  Comment 
The debt to equity ratio or D/E ratio is a financial ratio which reflects a firm's ability to raise funds or capital to and then to repay it.
MarketWatch  May 21  Comment 
Boston-based publisher Houghton Mifflin Harcourt announced Monday that it has filed for Chapter 11 bankruptcy protection, a move that should eliminate $3.1 billion of debt through a debt-to-equity transaction. The company plans to maintain its...
Flightglobal  May 13  Comment 
Hawker Beechcraft has revealed that the company will have new owners after emerging from a financial restructuring under Chapter 11 bankrutpcy protection...




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The debt to equity ratio is a measure of the company's total long-term debt divided by shareholder's equity

The debt to equity ratio gives the proportion of a company (or person's) assets that are financed by debt versus equity. It is a common measure of the long-term viability of a company's business and, along with current ratio, a measure of its liquidity, or its ability to cover its expenses. As a result, debt to equity calculations often only include long-term debt rather than a company's total liabilities.

A high debt to equity ratio implies that the company has been aggressively financing its activities through debt and therefore must pay interest on this financing. If the company's assets generate a greater return than the interest payments, then the company can generate greater earnings than it would without the debt. If not, however, and the company's debt outweighs the return from its assets, then the debt cost may outweigh the return on assets. Over the long-term, this would lead to bankruptcy . Investors should take this into consideration when investing in a company with a high debt to equity ratio, especially in times of rising interest rates.

Debt to equity ratios vary across industries. Capital intensive industries such as airplane manufacturers tend to have higher debt to equity ratios -- typically greater than 2. Less capital intensive industries, such as a software company, can have lower debt to equity ratios of under .5.

Examples

  • To start, Widgets Inc. has long term debt of $1 million and shareholder's equity of $1 million for a debt to equity ratio of 1, which is fairly standard in the widget industry.
  • To increase production, Widgets Inc. enters into a loan of $2 million in order to finance a new widget manufacturing facility, which increases its debt to equity ratio to 3 (=[$1 million previous debt + $2 million in new debt]/[$1 million in equity]) . The company pays 5% interest on the loan while its new facilities generate a 7% return. In this case, a higher debt to equity ratio allows the company to increase earnings beyond what would have been possible otherwise. The high debt to equity ratio is worthwhile for the company.
  • One year later, however, interest rates on the loan rise to 9%. Now, the company is paying more for its debt than the 7% it is generating out of its new facilities. The company's high debt to equity ratio and increasing debt payments now put the company at risk of going bankrupt.
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