Question

You are analyzing the leverage of two firms and you note the following​ (all values in millions of​ dollars):

	Debt	Book Equity	Market Equity	Operating Income	Interest Expense
Firm A	500.9	304.4	396.3	98.5	49.2
Firm B	80.7	33.1	39.9	8.5	7.1

a. What is the market​ debt-to-equity ratio of each​ firm?

b. What is the book​ debt-to-equity ratio of each​ firm?

c. What is the interest coverage ratio of each​ firm?

d. Which firm will have more difficulty meeting its debt​ obligations?

Answer 1

	Debt	Book equity		Market equity	Operating income	Interest expense
Firm A	500.9	304.4		396.3		98.5		49.2
Firm B	80.7	33.1		39.9		8.5		7.1
Answer a
Market debt to equity	=	Total debt / (total debt + market value of equity)
Firm A	=	500.9/(500.9+396.3)
	=	0.56
Firm B	=	80.7/(80.7+39.9)
	=	0.67
Answer b
Book debt to equity	=	Total debt / Book equity
Firm A	=	500.9/304.4
	=	1.65
Firm B	=	50.7/33.1
	=	1.53
Answer c
Interest coverage ratio	=	EBIT or Operating income / Interest
Firm A	=	98.5/49.2
	=	2.00
Firm B	=	8.5/7.1
	=	1.20
Answer d
Firm B will have more difficulty in meeting its debt obligations as interest coverage ratio of firm B is lesser than that of Firm A