If a company's debt to equity ratio is greater than 1:1, does this mean that shareholder's equity is negative?
You could have a debt to equity ratio greater than 1 and have positive shareholder equity. For example:Let's say you have debt balance of $500, equity of $100. The debt to equity is 5:1, but you still have a positive shareholder equity number.A lot of companies have a debt to equity ratio greater than 1. It's not a bad thing. It's just worrisome when the debt burden is so large that the company might not be able to pay it back or even make the interest payments.
What is debt equity ratio?
It is the Debt (Outstanding Loans or Borrowings) divided by the Equity(Money invested in the company by its shareholders minus any accumulated losses). Equity is the company’s own money while debt is what it borrows from lenders like banks, Finance Companies etc.It is supposed to be indicative of the financial health of the company. A Debt:Equity ratio of less than 1 means the company has borrowed more money than its shareholders have invested in it. This should generally not be a problem if the company’s business generates returns(ROCE - Return on Capital Employed) higher than the rate at which it has borrowed money (Cost of Funds).For example, a company has borrowed money from Banks at 12% and puts this money to work into a business that generates returns of 20%. So after paying interest to the banks at 12%, the company will be left with 8% returns that is available for its shareholders.Let’s say this company had Debt:Equity ratio of 1:1. Or out of every Rs 100, the company has borrowed Rs 50 and received Rs 50 from its shareholders(investors). It generated at a return of Rs 20 on this Rs 100. Of this, Rs 6(12% of 50) is paid to banks as interest and the remaining Rs 14 is available for shareholders. This translates to a return of 28% before taxes(Pre-Tax Return on Equity) for the shareholders. You can try this calculation for different levels of profitability and Debt:Equity ratio. From a business standpoint, it will make sense to borrow if the business is able to generate higher returns than the cost of borrowing.However, on its own, the Debt:Equity ratio is indicative of jack (-nothing) and it is just a number. As you saw above, you have to see it in relation to other Financial Ratios of the business such as the Return on Equity, Return on Capital etc.In addition, certain kinds of businesses will always have high D:E ratios (>5) like Banks and Finance Companies because their raw material itself is money. Whereas for another type of businesses, D:E ratio will always be very low as banks will not lend to them. This could be because returns of the business are very volatile(trading businesses) or it is still loss making(early stage start-ups).
What is the Cost of equity?
Diddy Corp. stock has a beta of 1.3, the current risk-free rate is 6 percent, and the expected return on the market is 13.50 percent. What is Diddy’s cost of equity? (Round your answer to 2 decimal places.) Cost of equity_____%
Why are preferred stocks categorized as equity instead of debt?
In terms of corporate finance they are different instruments. Preferred stock in a company has certain benefits over common shares (liquidity preference normally) but it is still equity. It entitles the holder to a percentage share of the company's profits. It may sometimes have fixed dividends which could make it feel like a debt obligation, but it still is a different instrument and doesn't have capped upside. Debt is different in that it has a fixed, capped payout (the amount the company owes you and the agreed upon interest). Debt generally has preference over any type of equity, including preferred shares, in the event of the liquidation of the company. I believe the terms are more similar in real estate investing but I don't know as much about that area. There is an article here: What is meant by “Preferred Equity” in Real Estate Ventures?: Real Estate Law Blog | Olshan Law
Flotation Costs?
What is the initial cost of the plant if the company raises all equity externally? 114m * 1.084 = $123,576,000 What is the initial cost of the plant if the company typically uses 65 percent retained earnings? Convert debt to equity TO debt to capital to calculate the weight of debt in the capital structure... Debt to capital "D/C" = D/E / (1 + D/E) = 0.85 / 1.85 = 0.45946 thus, equity to capital is (1 - D/C) = 0.54054 cost financed from retained earnings: 114m * 0.65 = 74,100,000 remainder to finance with new capital: 114m - 74.1m = 39,900,000 if that amount is financed at the same debt and equity proportions as the existing capital structure... 39,900,000 * 0.45946 = 18,332,432.43 needs to be raised from debt, thus the cost of that is: 18,332,432.43 * 1.039 = 19,047,397.29 and 39,900,000 * 0.54054 = 21,567,567.57 will need to be raised from new equity, which will cost: 21,567,567.57 * 1.084 = 23,379,243.25 For a total cost of: 74,100,000 + 19,047,397.29 + 23,379,243.25 = 116,526,640.54 The other way you could do this is to weight the flotation costs based on the existing capital structure and then multiply the financing need by 1 + weighted flotation cost. weighted flotation cost: (0.039 * 0.45946) + (0.084 * 0.54054) = 0.01792 + 0.04541 = 0.06332 39,900,000 * 1.06332 = 42,426,640.53...plus the 74,100,000 from retained earnings = 116,526,640.53 (off a penny from above due to rounding) What is the initial cost of the plant if the company typically uses 100 percent retained earnings? $114m