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Debt/Equity Ratio
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company has taken on relatively little debt and thus has low risk.
If a lot of debt is used to finance increased operations (high debt to equity), the company
could potentially generate more earnings than it would have without this outside financing. If
this were to increase earnings by a greater amount than the debt cost (interest), then the
shareholders benefit as more earnings are being spread among the same amount of
shareholders. However, if the cost of this debt financing ends up outweighing the returns that
the company generates on the debt through investment and business activities, stakeholders
share values may take a hit. If the cost of debt becomes too much for the company to handle,
it can even lead to bankruptcy, which would leave shareholders with nothing.
2. The personal debt/equity ratio is often used in financing, as when an individual or
corporation is applying for a loan. This form of D/E essentially measures the dollar amount of
debt an individual or corporation has for each dollar of equity they have. D/E is very
important to a lender when considering a candidate for a loan, as it can greatly contribute to
the lenders confidence (or lack thereof) in the candidates financial stability. A candidate
with a high personal debt/equity ratio has a high amount of debt relative to their available
equity, and will not likely instill much confidence in the lender in the candidates ability to
repay the loan. On the other hand, a candidate with a low personal debt/equity ratio has
relatively low debt, and thus poses much less risk to the lender should the lender agree to
provide the loan, as the candidate would appear to have a reasonable ability to repay the loan.
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