Question

In: Finance

-What does a high Debt to Capital ratio tell you about a company? -What does a...

-What does a high Debt to Capital ratio tell you about a company?

-What does a high Debt to EBITDA ratio tell you about a company?

these are for my own personal understanding about some Leverage ratios go as in depth as you can. also what is important to consider when comparing these ratios with those of other companies in the same industry?

Solutions

Expert Solution

1.Debt to capital ratio is calculated as follows= debt/debt + shareholder's equity.

This ratio measures a company's capital structure,financial solvency and degree of leverage at particular point in time.The debt to capital ratio gives analysts and investors a better idea of a company's financial structure and whether or not the company is a suitable investment.All else being equal,the higher the debt to capital ratio,riskier the company.This is because a higher ratio,the more the company is funded by debt than equity,which means a higher liability to repay the debt and greater risk of forfeiture on the loan if the debt cannot be paid timely.A high debt/equity ratio is often associated with high risk; it means that a company has been aggressive in financing its growth with debt. If a lot of debt is used to finance growth, a company could potentially generate more earnings than it would have without that financing,However a specific amount of debt may be crippling for one company,the same amount could barely affect another.Thus using total capital gives a more accurate picture of the company's health because it frames debt as a percentage of capital rather than as a dollar amount.While using Debt to Equity ratio of comparison, it is important to note that companies chosen should be of the same sector.

2. Debt to ebidta ratio is calculated as follows= Debt/ EBITDA

This ratio measures the amount of income generated and available to pay down debt before covering interest ,taxes,depreciation and amortization expenses.This measures the ability to pay off it's incurred debt. A high ratio result could indicate that the company too heavy debt load.banks often include a certain debt/ebitda target in the covenants for business loans, and a company must maintain this agreed upon level or risk having the entire loan become due immediately.This metric is commonly used by credit rating agencies to asess a company's probabability of defaulting on issued debt, and firms with a high debt /ebidta ratio may not be able to service their debt in an appropriate manner leading to a lowered credit rating.When lender's and analyst look at this ratio.they want to know how well the firm can cover it debts. Some industries are more capital intensive than others, so a company's debt/ebidta ratio should only be compared to the same ratio for other companies in the same industry . In some industries a debt/ebidta ratio of 10 could be completely normal,while in other industries a ratio of 3 to 4 is more appropriate.


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