# Estimating the Proportions of Capital

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.)