Question

Why do firms have different debt to equity ratios across industries? What is one of the factors, which determines a firm’s target debt-equity ratio? (Please provide figures for a specific industry benchmark along with some key players in that market) 400-500

Answer 1

Firms have different debt to equity ratios across industries :

Some of the main reasons why deb/ equity ratio varies greatly from one industry to other, and even between companies within an industry, include different level of capital intensity between industries, and whether the nature of the business makes it relatively easier to manage a high level of debt.
The industries that typically have the highest D/E ratios include utilities and financial services.
Wholesalers and service industries are commonly among those with the lowest D/E ratio.

1) The capital intensive existence of the industry is one opf the main reasons why D/E ratio varies. Capital intensive industries, such as oil and gas refining and telecommunications, need significant financial capital and vast quantities of money to mfg. products and or services.
2) Another reason why D/E ratio varies depends on whether the company structure means it can support high level of debt. for Example, Services offer steady income ; dmand for their services remains fairly stable regardless of overall market condition.

Factors which determines a firm’s target debt-equity ratio :

1.Assets Structure : The structure of he properties also influences the choice of capital structure. there are 2 assets categories that are : general assets and special purpose assets. generally , the actual state owned companies use the general pupose assetsas they can make good collateral. But they are highly leveraged. Whereas the technology research companies use special purpose assets. These companies are not highly leveraged.

2. Taxes : Taxes are effectively free. therefore, having high debt is favourable fo companies with high tax rate, as the debt would effectively reduce the ttax burden. Advantages under such situation are greater for companies who plan to move to debt if the tax rate is higher.

3. Operating Structure : This is also an important factor in choosing the structure of capital. Companies with less operating leverage are in a better position as there is less risk to the business. On the other side, businesses with a high operating leverage face difficulties due to the increased risk.