Winchell Investment Advisors is evaluating the capital structure of Ojai Foods. Ojai’s balance sheet indicates that the firm has $50 million in total liabilities. Ojai has only $40 million in short- and long-term debt on its balance sheet. However, because interest rates have fallen dramatically since the debt was issued, Ojai’s short- and long-term debt has a current market price that is 10 percent over its book value or $44 million. The book value of Ojai’s common equity is $50 million but the market value of the equity is currently $100 million.
a. What are Ojai’s debt ratio and interest-bearing debt ratio calculated using book values?
b. What is Ojai’s debt-to-enterprise-value ratio calculated using the market values of the firm’s debt and equity and assuming excess cash is zero?
c. If you were trying to describe Ojai’s capital structure to a potential lender (i.e., a bank), would you use the book-value-based debt ratio or the market-value-based debt-to-enterprise-value ratio? Why?

  • CreatedOctober 31, 2014
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