Debt-to-Equity Market Value, is the Long-term Debt over the Market Value of the company. This is another
Fantastic news! We've Found the answer you've been seeking!
Question:
The calculation is as follows:
Debt-to-Equity Market Value Ratio =(Long-term Creditors + Short-term Creditors + Subordinated Loans + Insurance Funds) / Market CapitalizationObserve that, as we discussed in our class notes:Equity fair value critically depends on expected earnings, equity book value and earnings volatility.The above holds because the firms always have an option to default on equity holders and liquidate assets.Meanwhile, research shows that debt value increases when earnings become more volatile in the proximity of default.The rationale for this is that increased earnings volaitlity allows firms to use 'good' periods of earnings to refinance debt at lower interest rates, raising price of debt.
Considering the concept of Debt-to-Equity MV Ratio above, suppose we have three companies:All have total capital at $1 billionLong-term Creditors Short-term Creditors Subordinated Loans Insurance Funds Market Cap
Company A $500 million $300 million $200 million $0 $2 billion
Company B $500 million $200 million $300 million $0 $2 billion
Company C $200 million $300 million $500 million $0 $2 billion
All three companies have identical Debt-to-Equity MV Ratios.
All three companies experience identical shocks to their revenues
Related Book For
Auditing a risk based approach to conducting a quality audit
ISBN: 978-1133939153
9th edition
Authors: Karla Johnstone, Audrey Gramling, Larry Rittenberg
Posted Date: