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Debt to equity means Book value of equity, and book value of debt for that matter for the most part.
What if there is a huge difference between book value and market value? The point of debt/equity is to determine a leverage measure, i.e. a measure of how much of the assets where bought with equity as opposed to debt. How much money the firm received from equity will be in the book value, not in the market value (which may determine how much money the firm will receive from secondary offerings, if applicable). So the book value of the equity is more appropriate then the market value.
Book debt and book equity is typically used when reporting D/E ratios. However, whether it is acceptable to use D/E based on book values depends on what you are doing. For example, in unlevering/relevering betas and WACC calculations, you should be using market value of debt and market value of equity, but for investment grade firms the former is typically proxied by the book value of debt.
Proper method of calculating Debt/Equity Ratio? (Originally Posted: 09/30/2013)
After doing some research on the Debt/Equity ratio I've come a across several ways to calculate it. I've seen (Total Liabilities/Share Holders Equity), or ((Long-Term Debt + Notes Payable)Share Holders Equity) or (All interest bearing liabilities/Share Holders Equity). So I'm pretty confused as to what to use.
I'll add some context to my situation.For a school assignment I'm trying to figure out the WACC of a brokerage firm that just went public, but I first need there P/E ratio. ( I already have the other information I need from other comparable firms) I'm trying to get the Debt/Equity ratio for this new company via their balance sheet. On their balance sheet this company has no long-term debt nor do they have any outstanding notes payable. However, being a brokerage firm they hold large sums of their customers cash, and pay their customers interest on it. This cash is listed as liabilities payable to customers on the balance sheet and totals $720 million. Their current stock holders equity is $72.9 million.
My question is, is it correct to assume that their D/E ratio is 720/72.9 = 9.87?
Or would it be 0 because it has no outstanding bank notes, bank loans or bonds?
how are you using p/e ratio?
Sorry, that was my bad. I meant to type D/E. I edited it for correction.
there are various ways of doing it - hard to say that one is the most "right", although a few can be chalked up to academically incorrect (e.g. all liabilities is just stupid whereas LTD/Equity would have merit in some forms of analysis)
I like (interest bearing liabilities + PV of Operating Leases)/Equity - tends to be the most consistent across the board
Also note that in most contexts where you are using it in a bank, the equity referring to by nontarget is market value of equity (not book value). That would be for things like credit stats, WACC calculation etc.
There isn't really a "right or wrong" way to do some of these exercises. Generally L/E gives you a back of the envelope answer. LTL/E gives you a more refined answer. If you simply take interest-bearing, you will obtain an even more accurate measure, but it takes longer.
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