A more comprehensive measure of overall indebtedness is the equity multiplier

A more comprehensive measure of overall indebtedness

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A more comprehensive measure of overall indebtedness is the equity multiplier, which relates assets to equity as follows: equity rs' Stockholde Assets multiplier Equity . While this measure is not as easily interpreted as long-term debt to total assets, it will assist in illustrat ing debt as a “lever” that magnifies return on assets. The equity multiplier is bounded from below at one. Consider a firm with no financial leverage. Its only funding is equity, so the ratio of assets to equity is one. If that same firm now replaces equity with debt, while keeping assets the same, the denominator will decline. Because the numerator does not change, the equity multiplier begins to rise above one. The next section will expand upon the importance of this measure, which links ROA and return on equity (ROE). The appropriate relationship between debt and assets is driven by the level of tangible assets and business risk. All else being equal, there tends to be a positive relationship between the level of tangible assets and use of financial leverage, because tangible assets can be used as collateral against the debt. Also all else being equal, there tends to be a negative relationship between the degree of business risk and the use of financial leverage. The next section illustrates how any debt magnifies ROA, and more debt leads to greater magnification. Therefore, if a firm’s business is inherently volatile (e.g., technology intensive businesses), magnification of that volatility with debt is generally deemed undesirable. The debt management ratios presented in Table 4 below show that long-term debt has declined as a percentage of assets for Starbucks between 2010 and 2012. This is because Starbucks had a single bond issue outstanding over the period. Starbucks’ Annual Reports disclose that on August 2007, the company issued $550 million of 6.25% Senior Notes due in August 2017. An annual interest rate of 6.25% on this debt is payable semi-annually, half on February 15 and half on August 15 of each year. Since the terms of the Notes stipulate that the $550 million principal is not paid until the Notes mature, the long-term debt balance is For the exclusive use of T. Tran, 2018. This document is authorized for use only by Tam Tran in Business Economics and Strategy-1 taught by Metin Cakir, University of Minnesota from January 2018 to July 2018.
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BAB036N J ULY 2013 Starbucks Corporation: Financial Analysis of a Business Strategy 12 unchanged over the three years. As assets have grown and long-term debt has remained unchanged, the long-term debt to total assets measure has declined. Similarly, the more comprehensive equity multiplier declined over the three years. This says that, in addition to the company’s decision to refrain from issuing more long -term debt to support its growing asset base, other sources of debt financing have declined in importance as well relative to equity financing. One possible explanation for this is the company’s profitability: as Starbucks generated and retained net income each year, its retained earnings balance increased. This powerful source of internally-generated funds means that the company
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  • Spring '14
  • Davis,ElizabethE
  • Balance Sheet, Revenue, Generally Accepted Accounting Principles, Starbucks Corporation

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