Question

		Assets				Total Debt and Equity
Current Assets		$200,000,000		Total debt equity		$220,000,000
				Common stock		$30,000,000
				Capital Surplus		80,000,000
				Accumulated retained earnings		170,000,000
Net Fixed Asset	$300,000,000			Total shareholders Equity		$280,000,000
Total Asset	$500,000,000			Total debt and shareholders equity		$500,000,000

a) What is the debt equity ratio on book values

b) Suppose the market value of the company's debt is $225 million and the market value of equity is $670million. What is the debt equity ratio based on market values?

c) Which is more relevant, the debt equity ratio based on book values or market values? Why?

Answer 1

A) Debt equity ratio on book values

=Total debt /Total shareholders Equity

=$220,000,000/$280,000,000

=0.79

b)

debt equity ratio based on market values

=market value of the company's debt/market value of equity

=225/670

0.34

C)Market Values are more relevanta as compared to book value as market values are based on current situation of the market and represent true worth whereas book values are mere historical figures.