Leverage ratios in Intercorporate investments

[castintosea]

PierreCFA,

Why is this not true, D_A/E_A > (D_A+D_S)/(E_A+FMV_S) if D_SA ?

Under partial goodwill, denominator is not FMV_S.

[PierreCFA]

@castintosea

Under partial goodwill, suppose acquirer buys b (%) of subsidiary company. The leverage in acquisition method is

(D_A+b*D_S)/(E_A+b*FMV_S)

For the second part, I made a mistake about the amount of Debt and Equity after acquisition.

The leverage in partial goodwill acquisition method must be (D_A+D_S)/(E_A+b*FMV_S)

So

D_A/E_A > (D_A+D_S)/(E_A+b*FMV_S) <=> D_A/E_A > D_S/(b*FMV_S)

I think this is the right formula now (or maybe not yet )

[castintosea]

Thanks. I got the first part.

But I think its not b*D_S but 100% D_S.

Equity is less than full goodwill also. FMV_S less the difference between full goodwill and partial goodwill.

[PierreCFA]

@castintosea

Under partial goodwill, suppose acquirer buys b (%) of subsidiary company. The leverage in acquisition method is

(D_A+b*D_S)/(E_A+b*FMV_S)

For the second part, I made a mistake about the amount of Debt and Equity after acquisition. The debt after acquisition is D_A+100%*D_S

About the value of equity after acquisition, I forget how to calculate it. I’m not sure whether you are right. Could you explain why the equity in partial goodwill method is equal to FMV_S less the difference between full goodwill and partial goodwill?

[castintosea]

Because debt is the same under both methods and total assets higher under full goodwill. So equity is higher for the same amount.

[PierreCFA]

Yes I see. Thanks

[tarun]

Old thread here.

Why Equity method will have Assets of 10+1 …it shd remain 10

why Equity = 2+1 …it shd remain 2…

only adjustment shd movement of cash from CA to Investment Account…

Is this correct?

Consolidation method +2 in equity is coming by way of Minority interest…should we consider it as equity?

[tarun]

@40yoCFAcandidate

rex, the best way to approach this is through a simplified example. It can illustrate the concepts very well. but to get to the end, D/E will almost always be lower under the Equity Method.

Parent before acquisition:

• Assets = 10. Liabilities = (8). Equity = 2. Therefore D/E = 8/2 or 4

What happens when we throw in a simple 50% acquisition of a company Assets=6. Liabilities = (4). Equity = 2 Do your ratios under consolidation and Equity method and see what happens:

• Equity Method: Assets = 10+1. Liabilities = (8). Equity = 2+1. Therefore D/E = 8/3 or 2.67.
• Consolidation: Assets = 10+6. Liabilities = (8)+(4). Equity = 2+2. Therefore D/E 12/4 or 3.0

You can use this simplified example to see how various ratios play out and to help it make intuitive sense.

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