Your Questions About Lower Debt To Equity Ratio

Ruth asks…

Modigliani-Miller proposition with taxes: choosing between debt and equity?

Equity Plan Debt Plan
Earnings 1000 1000
(EBIT)
Interest 0 (400)
(rB)
Earning bf taxes 1000 600
(EBT)
Earnings after taxes 600 360
([EBIT-rB]*(1-T))
Total cashflow to 600 760
shareholders and
bondholders
(EBIT*(1-T)+TrB)

By raising its debtequity ratio, the firm can lower its taxes and increase its total value.

Why is that true?

I thought that taxes expense is the same as interest expense, so the value of the firm would not change. However, we add taxrate*interest back to cashflow. Is it like a goverment rule or something?

richmama answers:

Under M-M, the value of the leveraged firm equals the value of the unleveraged firm PLUS the value of the “Debt Tax Shield”

By raising debt, the increase in interest is deductible.Taxes are lowered and the value of the firm increases.

In the absence of taxes, there are no benefits to increasing leverage.

Obviously, in the real world there are limits to increasing leverage because of the threat of bankruptcy, the risk increases and hence the cost of debt increases as well.

Hope that helps!

William asks…

What Are Your Opinions On These Stocks Read Details?

I have been researching for hours and I think I have come up with some VERY good stocks with great potential for investing RIGHT NOW. They have high EPS increases since the same quarter last year AND low debt to equity ratios and current ratios are good. The Three stocks are as follows and you may research

UCTT—–this stock seems pretty good

VDSI—–Very good stock with some NEW potential services

EML—–The best I have found so far and a little LESS VOLATILE than the rest meaning if are bull maret quits it may be better to invest in this one.

OPINIONS PLEASE?? 🙂

richmama answers:

First off, hours? If you do this often, you might consider subscribing to a service of some sort where you can find stocks a little more quickly.

The criteria you’re using has some similarities to the CANSLIM method that investors.com uses. They offer a free two week trial with a subscription to Investors Business daily. You can see more about the method on their site.

Investools.com also has many great screening tools to help.

That said, on with the show.

UCTT – as you said, fundamentally pretty decent. Great earnings growth and rated 3.25 on a 4.0 scale overall, which is very good. Technically, it’s just crossing over it’s moving average right now and looks to be headed at least to 17. I’d have my stop placed just below 14, so not a bad reward/risk ratio.

VDSI – an even stronger stock than the first one. 3.50 rating of 4.0 also in the semi industry which recently has had some cash flow into it. Technically, also better than the first one, very strong uptrend. Just bouncing off of its moving average, I’d say it’s a go under my rules. 🙂 22.52 with a stop around 21.48ish, it’ll probably go to about 26.50 before pulling back next, if I had to guess. (What a year it’s had!)

(just remember, you trade what actually happens, not what you’d like to happen)

EML – a little stronger industy group, and the stock has almost reached its prestock price in just eight months. Bummer it’s not optionable. I couldn’t find as good estimates on their financials as on the others, but the stock is still rated very strong. Technically, I like VDSI more, but this one still looks ok. 30 looks to be good support for now, so for a little over a dollar of risk, you’ve got some good upside potential as long as you remember to move your stop up as the stock moves.

Hope that helps!

Susan asks…

need help with FInancails. What do leverage ratios measure? is it good to have a higher leverage?

i need help analyzing total debt ratio, debtequity ratio, equity multiplier

also, what does ROA? ROE and Profit margin mean? is it good for those numbers to be low or high?

richmama answers:

Leverage ratios measure how much debt a company has compared to equity and assets. The higher the ratio the higher the leverage and the higher the risk.

Richard asks…

Please, need help from an expert in accounting, please!? is this good or bad? why?

hello..
what does this mean?
a company’s debt ratio is identical to that of the industry standard. Also, the debt equity ratio is identical to that of the industry, but the company’;s Times Interest Earned ratio is slightly lower when compared with the industry standards.. what does this mean?how is the company doing when it comes to debt? thanks.

richmama answers:

The debt ratio is normally how much a company owes (normally via loans) in relation to the value of its assets. The higher the debt ratio, the less the value of the company.

Equity is normally defined as the amount of capital (ie money received from issuing shares). The debt equity ratio shows how much money received by a company is from borrowing via loans vs capital. The former ie debt is normally affected by interest, the latter by dividend.

No one looks at interest earned ratio and I suppose you are talking about price earning ratio. This normally defines how much the share price is compared to its profits/revenues (on a per share basis).

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