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    Debt Ratio

    The debt ratio is calculated by dividing total debt by total assets. This gives us an idea about how much of the firm is financing its activities with debt. Other debt ratios include the debt-to-equity ration and the equity multiplier. These ratios provide information about how solvent the firm is on an asset basis. That is, if the firm’s assets had to be sold today, would the proceeds be enough to pay back the firm’s creditors, and what would be left to give to the equity holders? A firm is considered insolvent if its debt ratio is 1, and typically the proceeds from liquidated assets in bankruptcy are not enough to cover a firm’s creditors.

    The debt-to-equity ratio is calculated by dividing total debt by total equity. It lets us know the value of the firm that is financed with debt in relation to the value of the firm financed by equity.

    The equity multiplier is found by dividing total assets by total equity. It lets us know how many times larger the firm is in relation to the amount of equity that is invested in a firm.

    Because the book value of debt is not adjusted for risk or interest rates, the book value of debt may differ substantially from its market value. We typically use the accounting or book value of debt, and this is one important thing we must take note of when using these ratios.

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