(Calculating debt ratio) (Related to Checkpoint 15.1 on page 534) Sharpgas plc £m £m Current assets Current liabilities 8 Long-term debt Shares Non-current assets 30 20 Reserves 36 36 You have just taken over a portfolio of bank clients including Sharpgas Plc. Their latest balance sheet is as above. What questions would you ask immediately with regard to their capital structure?
(Calculating debt ratio) (Related to Checkpoint 15.1 on page 534) Sharpgas plc £m £m Current assets Current liabilities 8 Long-term debt Shares Non-current assets 30 20 Reserves 36 36 You have just taken over a portfolio of bank clients including Sharpgas Plc. Their latest balance sheet is as above. What questions would you ask immediately with regard to their capital structure?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:15-1. (Calculating debt ratio) (Related to Checkpoint 15.1 on page 534)
Sharpgas plc
£m
£m
Current assets
6
Current liabilities
8
Long-term debt
Shares
Non-current assets
30
20
2
Reserves
36
36
You have just taken over a portfolio of bank clients including Sharpgas Plc. Their latest
balance sheet is as above. What questions would you ask immediately with regard to
their capital structure?

Transcribed Image Text:STEP 3: Solve
Calculating the four benchmark financial ratios found in Table 15.3, we get the following:
Ratio with
Ratio
Existing Common Stock with Debt
Financing
Ratio
Formula
Ratio
Financing
Debt ratio
Total Liabilities
35.2%
26.4%
51.5%
Total Assets
Interest-bearing
Interest-Bearing Debt
20.1
15.1
40.2
debt ratio
Total Assets
Times interest
Net Operating Income or EBIT
27.08
31.25
11.72
earned
Interest Expense
Depreciation Amortization
6.84
8.20
3.08
EBITDA
Earnings Before
coverage ratio
Interest and Taxes
Expense
Expense
Principal Payments
Interest Expense + (-
1
Tax Rate
STEP 4: Analyze
Whether the entire $10 million is raised by issuing equity or by borrowing has a dramatic effect on the firm's
capital structure. For example, the debt ratio will either drop from 35.2 percent to 26.4 percent if equity is used or
increase to 51.5 percent if debt is used. The interest-bearing debt ratio will change in a similar manner, dropping
from 20.1 percent to 15.1 percent if equity financing is used and rising to 40.2 percent if debt financing is used.
The times interest eamed ratio will rise slightly from 27.08 to 31.25 with an equity offering but will drop to only
11.72 with a debt offering. The EBITDA coverage ratio, which incorporates consideration of noncash expenses
(depreciation) in the numerator as well as the repayment of principal in the denominator, will increase to 8.20 from
6.84 if equity is used and fall to 3.08 if debt is used.
To complete our benchmark analysis, we need to compare the above leverage ratios to the following com-
parable firm ratios:
Comparable Firm Ratio
Debt ratio
40%
Interest-bearing debt ratio
30%
Times interest earned ratio
22 times
EBITDA coverage ratio
6 times
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