Question

Company Being Researched is Snapchat-

4. Mechanics of Moving to the Optimal

a. If your firm’s actual debt ratio is different from its “recommended” debt ratio, how should they get from the actual to the optimal? In particular,

i. should they do it gradually over time or should they do it right now?

ii. should they alter their existing mix (by buying back stock or retiring debt) or should they take new projects with debt or equity?

Answer 1

To understand the above question, we first need to understand what is Debt Ratio.

Debt ratio of the company is defined as Total Liabilities of the company divided by Total Assets. A "recommended" debt ratio generally varies between 40% to 50%. Higher the debt ratio means company's higher exposure to Debt funds, which in general is not good for any company. An ideal company shoud have debt ratio of maximum 50%.

Answer to (i)

The process of taking the Company's Debt ratio from actual to optimal, should be done gradually over the time, reason being, if the company do it right now they will take impulsive decision, which may result in improper decision making.

Answer to (ii)

The company should alter their existing mix, since we are evaluating the company's existing ratio. So all the changes should be done by changing existing mix depending on the company's ratio.

The New Project should be financed in the both DEBT & EQUITY, in the form of ideal ratio as existing in the company. This will help to maintain its existion ratio.