标题: Capitalizing - leverage ratio [打印本页] 作者: EastCoastJ 时间: 2011-7-11 20:02 标题: Capitalizing - leverage ratio
Can some one please explain the effects of capitalizing as opposed to expensing.
How does this affect the leverage ratio?
Leverage = assets/equity
When capitalizing does your asset increase by the same amount as your equity?
(also when expensing, you reduce your net income... so does this reduce your equity by the same amount?)作者: sgupta0827 时间: 2011-7-11 20:02
also could someone explain this in regards to assets = liabilities + equity作者: Ionutzakis 时间: 2011-7-11 20:02
take a very simplified example of a company thats starts with $100 cash financed 50/50 with debt and equity
the beginning balance sheet is
assets - 100 (cash)
liabilities
debt - 50
equity - 50
assume the company generates revenue of $1000 during year 1, cost of sales $500, purchases new equipment for $100 (10 year useful life), no taxes, no interest expenses
case 1 - expense new eqpt
the income statement is
profit = 1000-500 - 100 = 400 which flows to equity. assuming all transactions are cash based, cash will increase by the same amount
liabilities
debt 50
equity 450 (50 beginning equity + 400 retained earnings for the year)
leverage ratio = 500/450 = 1.11
case 2 - capitalize new eqpt (=> only charge $10 depreciation for the year)
the income statement is
profit = 1000-500 - 10 = 490 which flows to equity.
the increase in cash is still 400 as before since accounting treatment (capitalizing vs expensing) does not impact cash flow (technically different taxes will impact cash, but we ignore taxes for this example)
the balance sheet becomes
assets -
cash 500 (100 begng cash + 400 cash generated during year)
equipment 90 (100 less 10 of accumulated depreciation)
total assets 590
liabilities
debt 50
equity 540 (50 beginning equity + 490 retained earnings for the year)
total liab + equity = 590
leverage ratio = 590/540 = 1.09
generally, both assets and equity are higher under capitalization. but equity increases by a larger % compared to the increase in assets hence the leverage ratio is lower.作者: mnieman 时间: 2011-7-11 20:02
perfect thanks v much for that作者: MythosHF 时间: 2011-7-11 20:02
When yuo capitalize, you inicrease your assets and your NI, which increase Equity. with the accoutnign equation, A = L + E, so we know A>E. That means that when you capitalize an asset, the equity will change by a higher percent than assets. In the leverage ratio A/E, E changes by a higher percentage than A so the denominator has a bigger percent change, meaning it has a bigger weight on the ratio. This will decrease the ratio.作者: btcapital 时间: 2011-7-11 20:02
Usually lower debt ratios (like d/e or d/a) are preferable. Im not fully sure if a lower leverage ratio is improving, although it would seem like it would be better if its the same rationale as the debt ratios. Then again, a lower leverage ratio leads to lower ROE and lower growth rate, which leads to lower stock price in DDM. I guess it may depend on what you mean by "better"? anyone have any thoughts?作者: JRossSter 时间: 2011-7-11 20:02
In this case the D/E ratio is a better measure of a company's leverage than the leverage ratio itself. Technically, when you capitalize the leverage ratio doesn't really improve because you'll have to depreciate or amortize the asset in the later years. Recognition of something like an ARO, on the other hand, leads to a permanent increase in both the D/E and the leverage ratios because you have a growing liability.作者: homie 时间: 2011-7-11 20:02
cokecan Wrote:
-------------------------------------------------------
> thanks,
>
> does improving the leverage ratio mean that the
> ratio goes lower?
