For purposes of financial analysis, all of the following should be adjusted with a change in interest rate, EXCEPT: A) the value of debt. B) interest expense. C) the value of equity. D) the debt-to-equity ratio. answer was B) interest expense. For the purpose of analysis, the value of debt and equity should be adjusted for a change in interest rates. A change in interest rates will change the debt-to-equity ratio, but the interest expense on the income statement will not be adjusted. Because changes in interest rates will change the market value of the debt, but not the coupon, interest expense will be unchanged. Guys why dont we adjust interest expense… reported Interest expense is based on IR at issue… so if the IR changes, shouldn’t we change interest expense as well?
sumit_kansal Wrote: ------------------------------------------------------- > Guys why dont we adjust interest expense… > reported Interest expense is based on IR at > issue… so if the IR changes, shouldn’t we change > interest expense as well? Assuming that the firm has fixed-coupon debt, the coupon payment (i.e. the interest expense) is contractually fixed. In other words, whatever happens to interest rates in the market, coupon payments don’t change. So, we don’t adjust it.
Interest expense is calculated as YTM (or interest at the time of instrument issue) *book value of debt. Since neither YTM not the book value of debt changes at changes in the interest rate on the market, IE is not adjusted.
Map1: My bad - thanks for the clarificaton.