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Accounting: Debt to Equity Ratio 1 Views
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Transcript
- 00:00
Accounting Allah shmoop debt to equity ratio All right Lots
- 00:07
of thinking about death Why so much Deep inspection Well
- 00:11
because when debt goes bad life gets really bad Like
- 00:16
you know company leverage is like adding nitrous oxide to
- 00:20
your gas tank It can make your car go really
Full Transcript
- 00:23
fast But when things go wrong well this happens So
- 00:27
framing how much is too much when it comes to
- 00:30
debt is a big deal and the ratios are in
- 00:33
Horton The big debt ratio that gets called upon by
- 00:36
nervous bond investors most of the time is the debt
- 00:40
to equity ratio which is simply this It's total debt
- 00:43
divided by total equity Well the most pragmatic of the
- 00:46
debt coverage ratios is the times interest covered ratio which
- 00:50
is just operating profits divided by interest expense Right And
- 00:54
why do you forget tax in this equation Because interest
- 00:57
costs are deductible against taxes So if you had a
- 01:00
year where your company had one hundred million dollars in
- 01:03
operating profits and no debt while at a thirty percent
- 01:05
corporate tax rate you'd pay thirty million bucks in taxes
- 01:09
the next year you take out two billion dollars in
- 01:11
debt at five percent Well you know two billion times
- 01:15
five percent or one hundred million dollars in interest Well
- 01:18
if you still had operating profits of one hundred million
- 01:21
dollars at that point you'd o zero taxes Why Well
- 01:25
we repeat because interest costs are deductible against taxes there
- 01:30
are cost of running the business Well basic idea is
- 01:32
that if you have a large multiple of interest costs
- 01:35
in the form of operating profits now then you should
- 01:37
be in good shape too Pay the interest on your
- 01:40
debt and lived to fight another day But if your
- 01:42
company's margins decline or should they God forbid go negative
- 01:46
Well and you're saddled with two billion dollars of debt
- 01:49
you would end up getting clear channelled That's not a 00:01:52.0 --> [endTime] good thing
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