Mark was recently hired by Boeing as a junior budget analyst.Here is the informa
ID: 2688139 • Letter: M
Question
Mark was recently hired by Boeing as a junior budget analyst.Here is the information that Mark has accumulated so far: The Capital Budgeting Projects: The tax rate used in his calculations is 32%. All projects are expected to have a 4 year life. The capital budget is $55 million and the projects are mutually exclusive. Because the projects do not qualify for accelerated depreciation, Mark will use the straight line depreciation method. Salvage value is expected to be zero. Capital Structures Mark has been asked to evaluate alternative capital structures for financing the chosen project. He has decided to evaluate 3 capital structures: no debt, 25% debt, and 45% debt. If debt is used, the cost of the debt will depend upon the amount of leverage in the capital structure. At 25% leverage, the before tax cost of debt will be 3%. At 45% leverage, the cost of debt rises to 5% for all projects. Cost of Capital: Mark knows that in order to evaluate the projects he will have to determine the cost of capital for each of them. BoeingExplanation / Answer
The debt-equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed. To a large degree, the debt-equity ratio provides another vantage point on a company's leverage position, in this case, comparing total liabilities to shareholders' equity, as opposed to total assets in the debt ratio. Similar to the debt ratio, a lower the percentage means that a company is using less leverage and has a stronger equity position. Formula: Components: As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings had total liabilities of $1,036.80 (balance sheet) and total shareholders' equity of $4,682.80 (balance sheet). By dividing, the equation provides the company with a relatively low percentage of leverage as measured by the debt-equity ratio. Looking for penny stocks that skyrocket? Variations: A conservative variation of this ratio, which is seldom seen, involves reducing a company's equity position by its intangible assets to arrive at a tangible equity, or tangible net worth, figure. Companies with a large amount of purchased goodwill form heavy acquisition activity can end up with a negative equity position. Commentary: The debt-equity ratio appears frequently in investment literature. However, like the debt ratio, this ratio is not a pure measurement of a company's debt because it includes operational liabilities in total liabilities. Nevertheless, this easy-to-calculate ratio provides a general indication of a company's equity-liability relationship and is helpful to investors looking for a quick take on a company's leverage. Generally, large, well-established companies can push the liability component of their balance sheet structure to higher percentages without getting into trouble. The debt-equity ratio percentage provides a much more dramatic perspective on a company's leverage position than the debt ratio percentage. For example, IBM's debt ratio of 69% seems less onerous than its debt-equity ratio of 220%, which means that creditors have more than twice as much money in the company than equity holders (both ratios are for FY 2005). Merck comes off a little better at 150%. These indicators are not atypical for large companies with prime credit credentials. Relatively small companies, such as Eagle Materials and Lincoln Electric, cannot command these high leverage positions, which is reflected in their debt-equity ratio percentages (FY 2006 and FY 2005) of 91% and 78%, respectively.