Refer to Table 17-3 of the textbook, copied in the next. What do you notice abou
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Question
Refer to Table 17-3 of the textbook, copied in the next.
What do you notice about the types of industries with respect to their average debt-equity ratios? Are certain types of industries more likely to be highly leveraged than others? What are some possible reasons for this observed segmentation?
Refer to Table 17-3 of the textbook, copied in the next.
What do you notice about the types of industries with respect to their average debt-equity ratios? Are certain types of industries more likely to be highly leveraged than others? What are some possible reasons for this observed segmentation?
Refer to Table 17-3 of the textbook, copied in the next.
What do you notice about the types of industries with respect to their average debt-equity ratios? Are certain types of industries more likely to be highly leveraged than others? What are some possible reasons for this observed segmentation? Debt as a Percentage of the Market Value of Equity and Debt (Industry Medians) High Leverage Radio and television 59.60 broadcasting stations Air transport Hotels and motels Building construction Natural gas distribution Low Leverage Electronic equipment Computers Educational services Drugs Biological products 45.89 45.55 42.31 33.11 0.58 9.53 8.93 8.79 8.05 DEFINITION: Debt is the total of short-term debt and long-term debt. SOURCE: Ibbotson 2011 Cost of Copital Yearbook (Chicago: Morningstar, 2011).
Explanation / Answer
There are various reasons why some industries use more leverage, If we can notice in the above list all the high leverage companies are very Capital intensive companies and need a high amount of capital to incorporate and need high amounts of working capital as well.
For example, if we compare Computers with Air Transport, a computers industry need hardware and a panel of assemblers for assembling If it is a computers Hardware industry and in case of Software all that a company need is computer systems and developers it is not a capital-intensive industry, whereas for an Air transport industry they need Flights(high capital requirement), Airport lease, Runway Maintenance, high number of maintenance people, engineers, and other employees. If we can observe here there is so much of capital requirement over here in comparison to computers industry.
Therefore in order to compensate for this short-term working capital requirement companies that require a high amount of capital go for debt funding for short term by raising capital in the bond market by issuing bonds of various maturities instead of equity.
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