Q. Which of the following is most likely to occur if the pension assets are not included in the weighted average cost of capital (WACC)? A. The debt-to-equity ratio will be understated. Why? If you include pension assets, the debt (numerator) will be increased, which will increase the debt-to-equity ration. But, wouldn’t the equity (denominator) be increased by the same amount thereby keeping debt-to-equity ratio the same? Please help.
no. say you have 10 mn assets and 10 mn liability (6mn equity, 4 mn debt) (ignoring pension assets of firm) so debt / equity ratio = 4/6 = 66.7 now say we include pension assets into firm asets amounting to another 6mn. the eqn now becomes: assets = 16mn, debt = 10 mn and equity = 6mn. debt to equity ratio now becomes 10 / 6 = 1.67 hence D/E ratio is increased when we consider pension assets.