Feel like I’m missing something obvious but here goes!!
Vol 4 Corporate Finance
page 39–Example 3
In "Solution to 3: line one says " a debt-to-equity ratio of 0.7 represents a weight on debt of 0.7/1.7=0.4118 so…"
Where does the 1.7 in the denominator come from?
Thanks-
Chip.
ChipM, D/E of 0.7 implies that for every 1 dollar of equity, the company has 70 cents of debt.
Taking this further, for every 1.70 dollars of capital (equity and debt), 1 dollar is equity and 70 cents is debt, so the weight of debt within the overall capital structure is given by 0.7/1.7.
Hope this helps!
A = E + D [Balance sheets balance]
A / E = (E + D) / E [Divide both sides by E]
= E / E + D / E [Separate the numerator]
= 1 + D / E. [E / E = 1]
Thus:
the proportion of debt = D / A = (D / E) / (A / E) = (D / E) / (1 + D / E),
and the proportion of equity = E / A = (E / E) / (A / E) = 1 / (1 + D / E).
Wojtek
S2000magician
Thanks to both of you for the fast replies–very helpful!!
ChipM
My pleasure.
(I can’t speak for Wojtek, but I suspect he’d say the same thing.)