Balance Sheet And Market Value
The most notable thing in the table presented above is the disparity between the actual market value and what is reported in ARC’s balance sheet. The balance sheet funding totaled to $1. 465 billion while the market value ballooned reaching $2, 390 billion. When compared, the difference is a staggering $20 million indicating that ARC owes more to its financiers than what it actually claims. The source of this huge difference is the disparity between the balance sheet amount of long-term debt and its market value. The company does not trade its bond so the yield is compared with companies issuing the same bonds.
When converted to its present value, the book value is significantly lower than the market value. Another is the amount of stockholder’s equity. It should be noted that in reality, more funds are generated from the sale of stocks than their attributed value in the company’s books. The difference in the numbers has several implications when the capital structure of the company is considered. Two specific financial ratios are often computed in order to look at the risk entailed by a business organization—the debt ratio and the long term debt to equity. The debt ratio looks at the portion of the company’s asset which is financed by creditors.
Accordingly, it “gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load” (Debt Ratio 2007). When computed using the balance sheet figures, ARC has a debt ratio of 68%. On the other hand, when market value is utilized the figure shrinks to 67%. This implies that 67-68% of ARC’s assets are financed by its creditors. In the industry as a whole, a higher debt ratio is an indication of higher financial risk because debt is often perceived as riskier method of financing. Thus, when market value is used, ARC has the chance of showing a better credit standing.
The disparity is small but not insignificant. It should be noted that investors often look at the credit exposure of the company by looking at the debt ratio. A small percentage can spell a huge difference when investors are making their choice. The debt to equity ratio on the other hand shows the proportion of creditors share to equity holders in the company’s resources. Accordingly, “A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt which can result in volatile earnings as a result of the additional interest expense” (Debt to Equity Ratio 2007).
Using the balance sheet data, ARC’s debt to equity ratio is 2. 16 while market shows a lower 1. 98. Both of this data shows that ARC’s debt is much greater than its equity account. For the balance sheet data, every dollar in ARC’s equity is matched by a corresponding $2. 16 in total debt. On the other hand, market value data shows that every dollar of equity only has a corresponding 1. 98 debt. In general, the computed ratios show the high exposure of the company to financial risk.
It should be noted that debt entails the payment of interest at regular intervals and face value (Keown et al 2005). References “Debt Ratio,” 2007, Investopedia. com. Retrieved 06 December 2007, from http://www. investopedia. com/terms/d/debtratio. asp “Debt to Equity Ratio,” 2007, Investopedia. com. Retrieved 06 December 2007, from http://www. investopedia. com/terms/d/debtequityratio. asp Keown, A. J. , Martin, J. D. , Petty, J. W. , and Scott Jr. , D. F, 2005, Financial Management principles and applications, Pearson/Prentice Hall International Edition, 10th Edition.
