Hi,
I am a bit confused when using debit:equity ratios instead of the actual amounts for equity and debit separately.
I have just completed questions 199 & 200 in the P&R:
When the questions says "... and a debt:equity ratio of 1:3" or "...an average debt/debt+equity ratio of 25%"
Are they referring to the amount of debt or equity?
How am I supposed to know how to apply these figures to get the answer?
Conveniently in question 199 they have used a ratio of 1:3, but what if the ratio was 2:3, where would the "2" go in the calculation?
For question 200, they have multiplied the Be by 0.75... does that mean that if the ratio was 45%, you'd multiply Be by 0.55?
Thanks
Simone
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Using debt:equity ratios
2y ago#1For example the first is debt: second equity
Then
1:3
It means no matter how much finance the company had they have it in the proportion 1:3
So 1/4 is debt 3/4 is equity for example
Or 25% and 75%
If it’s 2:3
It means it’s equal to 5 no matter how much finance they have
So 2/5 is debt 3/5 is equity
Or 40% and 60%
OK Thanks.
How do you know from the question which is debt and which is equity? To me, they are both referring to debt.
So in the first example debt is 25% and in the second example debt is also 25%
2y ago#3I haven’t got access to my kits at the moment
I am staying away with my family for the evening
Can you tell me what the question actually says so I can help you.
2y ago#4It must indicate debt is the first
Or does it say debt:equity ratio
If it does that means debt is the first proportion
Sure no problem. Thanks for helping. Questions are below:
199
Shyma Co is a company that manufactures ships. It has an equity beta of 1.6 and a debt:equity ratio of 1:3. It is considering a new project to manufacture farm vehicles. Trant Co is a manufacturer of farm vehicles and has an asset beta of 1.1 and a debt:equity ratio of 2:3. The risk free rate of return is 5%, the market risk premium is 3% and the corporation tax rate is 4%.
Using CAPM, what would be the suitable cost of equity for Shyma to use in its appraisal of the farm machinery project?
200
Leah Co is an all equity financed company which wishes to appraise a project in a new area of activity. It's existing equity beta is 1.2. The industry average equity beta for the new business area is 2.0, with an average debt/debt+equity ratio of 25%. The risk free rate of return is 5% and the market risk premium is 4%.
Ignoring tax and using CAPM, calculate a suitable risk-adjusted cost of equity for the new project?
2y ago#6It’s as I said
LOL great... thanks. I will try to figure it out myself.
2y ago#8Debt:Equity
Then the first figure is Debt and the second is equity
If it as a gearing calculation
Say D/D+E
It will be the same
Debt is first, equity second
OK - That's fine. I understand that, but earlier (Saturday) you said that the first question was Debt, and the second question was equity... that's why I got confused and asked how will I know which is which if they both refer to Debt first in the ratio.
Thanks for your help.
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