debt gearing

Examples of debt gearing in the following topics:

• Overview of Convertible Securities

  • It is a hybrid security with debt and equity-like features.
  • Although a CB typically has a coupon rate lower than that of similar, non-convertible debt, the instrument carries additional value through the option to convert the bond to stock, and thereby participate in further growth in the company's equity value.
  • The advantage for companies of issuing CBs is that, if the bonds are converted to stocks, the company's debt vanishes.

• Debt to Equity

  • Closely related to leveraging, the ratio is also known as risk, gearing or leverage.
  • The formula of debt/equity ratio: D/E = Debt (liabilities) / equity.
  • A similar ratio is the ratio of debt-to-capital (D/C), where capital is the sum of debt and equity:D/C = total liabilities / total capital = debt / (debt + equity)
  • The debt-to-total assets (D/A) is defined asD/A = total liabilities / total assets = debt / (debt + equity + non-financial liabilities)
  • Debt to equity can also be reformulated in terms of assets or debt: D/E = D /(A – D) = (A – E) / E

• Defining Financial Leverage

  • At its simplest, leverage is a tactic geared at multiplying gains and losses.
  • In short, the ratio between debt and equity is a strong sign of leverage.
  • Debt is often lower cost access to capital, as debt is paid out before equity in the event of a bankruptcy (thus debt is intrinsically lower risk for the investor).
  • Let's say equity represents 60% of borrowed capital and debt is 40%.
  • The organization owes 10% on all equity and 5% on all debt.

• Capital Structure Overview and Theory

  • For example, a firm that sells 20 billion dollars in equity and 80 billion dollars in debt is said to be 20% equity-financed and 80% debt-financed.
  • Gearing Ratio is the proportion of the capital employed by the firm which comes from outside of the business, such as by taking a short term loan.
  • It states that there is an advantage to financing with debt (the tax benefits of debt) and that there is a cost of financing with debt (the bankruptcy costs and the financial distress costs of debt).
  • The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing.
  • When that is depleted, debt is issued.

• Total Debt to Total Assets

  • The debt ratio is expressed as Total debt / Total assets.
  • Debt ratios measure the firm's ability to repay long-term debt.
  • The debt/asset ratio shows the proportion of a company's assets which are financed through debt.
  • If the ratio is greater than 0.5, most of the company's assets are financed through debt.
  • A company with a high debt ratio (highly leveraged) could be in danger if creditors start to demand repayment of debt.

• Striking Agreements to Avoid Bankruptcy

  • In general, creditors understand that bankruptcy is an option for debtors with excessive debt.
  • A debt restructuring is usually less expensive than bankruptcy.
  • Debt restructurings typically involve a reduction of debt and an extension of payment terms.
  • A debtor and creditor could also agree to a debt-for-equity swap, wherein a company's creditors generally agree to cancel some or all of the debt in exchange for equity in the company.
  • This simplifies the debtor's obligations and can result in faster debt repayment.

• Types of Private Financing Deals: Going Private and Leveraged Buyouts

  • LBOs use debt to secure an acquisition and the acquired assets service the debt.
  • As the debt usually has a lower cost of capital than the equity, the returns on the equity increase with the increasing debt.
  • In turn, this then led to insolvency or to debt-to-equity swaps, in which the equity owners lose control over the business and the debt providers assume the equity.
  • Senior debt: This debt is secured with the assets of the target company and has the lowest interest margin
  • Junior debt: This debt usually has no securities and bears a higher interest margin

• Trade-Off Consideration

  • It states that there is an advantage to financing with debt—the tax benefits of debt, and there is a cost of financing with debt—the cost of financial distress including bankruptcy.
  • The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases.
  • Of course, using equity is initially more expensive than debt because it is ineligible for the same tax savings, but becomes more favorable in comparison to higher levels of debt because it does not carry the same financial risk.
  • Therefore, one would think that firms would use much more debt than they do in reality.
  • Describe the balancing act between debt and equity for a company as described by the "trade-off" theory

• The Cost of Debt

  • Since in most cases debt expense is tax deductible, the cost of debt is computed as an after-tax cost to make it comparable with the cost of equity.
  • Thus, for profitable firms, debt is discounted by the tax rate .
  • The cost of debt can also be calculated by dividing the annual interest payment of the debt by its market value.
  • Cost of debt is equal to the annual interest payment of the debt divided by its market value.
  • Cost of debt equals the interest rate of the debt (composed of the risk-free rate and a credit risk premium) times one, minus the corporate tax rate.

• Debt

  • Debt is usually granted with expected repayment.
  • This leverage, the proportion of debt to equity, is considered important in determining the riskiness of an investment--the more debt per equity, the riskier.
  • A company uses various kinds of debt to finance its operations.
  • The various types of debt can generally be categorized into:
  • Treasury bills are one kind of debt issued by the U.S.