Question

"A firm has current assets that could be sold for their book value of $7,000,000. The book value of its fixed assets is $3,000,000, but they could be sold for $6,000,000 today. The firm has total debt at a book value of $1,500,000, but interest rate changes have increased the value of the debt to a current market value of $3,000,000. This firm's equity market-to-book ratio is ________. "

Answer 1

To calculate the equity market-to-book ratio, we need to determine the market value and book value of the firm's equity.

The book value of equity can be calculated by subtracting the total debt from the book value of the firm's assets:

Book value of equity = Book value of assets - Total debt

= ($7,000,000 + $3,000,000) - $1,500,000

= $9,000,000 - $1,500,000

= $7,500,000

Next, we need to calculate the market value of equity. It is generally not provided directly in the given information. However, we can derive it by considering that the market value of the firm's assets includes both the current value of fixed assets ($6,000,000) and the current market value of debt ($3,000,000). Therefore, the market value of equity would be:

Market value of equity = Market value of assets - Current market value of debt

= $6,000,000 + $3,000,000

= $9,000,000

Finally, we can calculate the equity market-to-book ratio as the ratio of market value of equity to the book value of equity:

Equity market-to-book ratio = Market value of equity / Book value of equity

= $9,000,000 / $7,500,000

= 1.2

Therefore, the equity market-to-book ratio for this firm is 1.2.