Company A has $45 million worth of common share capital, $3.5 million in retained earnings, $30 million in long-term debt and $2.5 million in preferred shares. Company B has $22.5 million of common share capital, $3 million in retained earnings, $51 million in long-term debt and $4.5 million in preferred shares. If both companies face a tax rate of 32%, cost of common share capital of 11%, cost of debt capital of 8%, cost of preferred share capital of 9.5%, which company is more highly levered?

Question

Quizplus · Accepted Answer

To determine which company is more highly levered, we need to calculate the debt-to-equity (leverage) ratio for each company.

Debt-to-equity ratio = Total Debt / Total Shareholders' Equity

For Company A:
Total Shareholders' Equity = Common Share Capital + Retained Earnings + Preferred Shares
= $45M + $3.5M + $2.5M = $51M

Debt-to-equity ratio = $30M / $51M = 0.588 or 58.8%

For Company B:
Total Shareholders' Equity = Common Share Capital + Retained Earnings + Preferred Shares
= $22.5M + $3M + $4.5M = $30M

Debt-to-equity ratio = $51M / $30M = 1.7 or 170%

Therefore, Company B is more highly levered with a debt-to-equity ratio of 1.7 or 170%.

Company a Has $45 Million Worth of Common Share Capital