An argument for using the book value of the equity when calculating leverage ratios is that
A)many of the bond covenants use ratios based on the book value of equity.
B)it is less variable than the market value of the equity.
C)it is a measure of the true economic value of a firm.
D)Both A and B are arguments supporting the use of the book value of the equity.

Question

Quizplus · Accepted Answer

Both A and B are valid arguments for using the book value of equity when calculating leverage ratios. Bond covenants often use ratios based on book value, so using this measure ensures consistency and compliance with these agreements. Additionally, fluctuations in the market value of equity can lead to inconsistent ratios, whereas book value is generally less variable. However, it should be noted that book value may not always reflect the true economic value of a firm, particularly if there are intangible assets that are not reflected in the balance sheet. Using the book value of equity for calculating leverage ratios is supported by both options A and B. Many bond covenants use ratios based on the book value of equity, and the book value of equity is less variable than the market value of equity. While option C is a reason some may argue for using the book value, it is not as strong of an argument as the other two options.

An Argument for Using the Book Value of the Equity