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How much can be borrowed in the following case to maintain a debt-equity ratio of...

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olivia61 | Student, Undergraduate | (Level 1) eNoter

Posted January 16, 2011 at 5:14 AM via web

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How much can be borrowed in the following case to maintain a debt-equity ratio of 0.75?

Hogi Co. has a total debt of $252,000 and stockholders' equity of $420,000. Hogi is seeking capital to fund an expansion and plans to issue an additional $180,000 in common stock. It is also negotiating with a bank to borrow additional funds.  The bank requires a maximum debt-equity ratio of 0.75.  What is the maximum additional amount Hogi will be able to borrow after the common stock is issued?

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justaguide | College Teacher | (Level 2) Distinguished Educator

Posted January 16, 2011 at 10:56 AM (Answer #1)

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Hogi Co. currently has a total debt of $252000 and it has issued equity for $420000. It plans to finance its expansion by issuing new equity worth $180000. The total value of equity issued would then be equal to $420000 + $180000 = $600000

Let the amount of money the company is able to borrow from the bank be equal to D. As the maximum debt-equity ratio that the bank is willing to accommodate is 0.75, we get D / $600000 = 0.75

=> D = 0.75*$600000

=> D = $450000

Currently the debt that the company has is $252000, so it can borrow an additional amount of $450000 - $252000 = $198000, while ensuring that the debt equity ratio does not exceed 0.75.

After the new stock is issued, the company can borrow an additional $198000.

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