Response to Classmates Discussions

Week 4 - Discussion Forum 2

Guided Response: Respond to at least two of your fellow students’ or instructor posts in a substantive manner and provide information or concepts that they may not have considered. Each response should have a minimum of 100 words and be respectful of others’ opinions and beliefs that differ from your own. Support your position by using information from the week’s readings. You are encouraged to post your required replies earlier in the week to promote more meaningful and interactive discourse in this discussion forum. Continue to monitor the discussion forum until Day 7 and respond with robust dialogue to anyone who replies to your initial post.

There two of my classmate’s discussion that need responded to. Marlon Fletcher and Lisa Schreiner

Marlon Fletcher

The debt-to-equity ratio is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. It is a measure of the degree to which a company is financing its operations through debt versus wholly-owned funds. The information needed for the debt-to-equity ratio is on a company's balance sheet. A low debt-to-equity ratio indicates a lower amount of financing by debt via lenders, versus funding through equity via shareholders. A higher ratio indicates that the company is getting more of its financing by borrowing money, which subjects the company to potential risk if debt levels are too high. A high debt to equity ratio generally means Delta has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.

Debt-to-equity ratio = Total liabilities/Total Shareholder equity 2019  1.12= (3,088+14,167)/ 15,358 2020  1.61= (5,105+17,866)/ 14,309

Note: total of Short-Term Debt & Capital Lease Obligation and Long-Term Debt & Capital Lease Obligation divided by Total Stockholders’ Equity

The times interest earned ratio is a measure of a company's ability to meet its debt obligations based on its current income. A better times interest earned number means a company has enough cash after paying its debts to continue to invest in the business. The higher the number, the better the firm can pay its interest expense or debt service. If the TIE is less than 1.0, then the firm cannot meet its total interest expense on its debt.

Times interest earned ratio = EBIT or Income before Interest & Taxes / Interest Expense 2019   21.99= 6618/-301 2020   Mar. 2020, Delta Air Line’s Interest Expense was $-79 Mil. Its Operating Income was $-410 Mil. And its Long-Term Debt & Capital Lease Obligation was $17,866 Mil. Delta Air Lines did not have earnings to cover the interest expense.

At this time I would be skeptical on lending money to Delta based on its use of debt. Recently most of the debt of Delta’s came from the COVID-19 epidemic and the limitations of flights international and domestic with numerous cancellations and laying off employee’s due to social distancing.

 

Porter, G., & Norton, C. (2018). Using financial accounting information: The alternative to debits and credits (10th ed.). Retrieved from https://www.cengage.com

Lisa Schreiner

FridayJun 5 at 5:55pm

Manage Discussion Entry

There are two ways to calculate the debt to equity ratio in financial statement analysis, total liabilities divided by total stockholder’s equity or long term debt divided by stockholder’s equity. I found most web based industry analysis sites applied the later formula. A company with the least amount of debt is an investor’s goal while analyzing potential options. A view about debt according to Broderson and Pysh (2014), “On the one hand, this allows the company to acquire more assets, which is great when times are good. On the other hand, it also increases the risk of the company if demand declines or competition intensifies. Out of all the metrics you’re going to learn, this one will likely be one of the most important: avoid companies with large amounts of debt. Warren Buffett likes a debt-to-equity ratio of 0.5 or lower” (pgs. 42-44). Starbucks reflects a debt to equity ratio for 2018 of 7.73% and 2019 of -1.79% (Table 1). The decrease year over year is not a positive situation for Starbucks, but rather an increase in long term debt and a deficit in stockholders equity reflect the company does not have the ability to meet interest and loan repayment requirements. This appears to be a trend for the industry as McDonald’s reflects a debt to equity ratio in 2019 of -5.20% (Macrotrends, 2020).

The times interest earned ratio indicates the percentage a company spends on interest expense compared to operating income. This figure is derived by dividing Income before Interest and Taxes (Operating Income in most cases) by Interest Expense. The higher the ratio, the more operating income or less interest obligations an organization possesses, indicating financial strength. Starbucks reflects a times interest earned ratio in 2018 of 33.82% and in 2019 14.2% (see Table 1). The significant decline in the ratio year over is year is attributed to a decrease in operating income while interest expense doubled, signaling an increase in debt. McDonald’s reflects a ratio of 8.08% reflecting a less attractive position than Starbucks relative to interest obligations (SEC, 2020).

Table 1

As a lender, I would not lend money to Starbucks due to the stockholder’s equity deficit, increasing debt, decline in revenue, loss of liquidity, and recent 100% increase in interest expense year over year.

 

References

Brodersen, S., & Pysh, P. (2014). Warren Buffett accounting book: Reading financial statements for value investing.   https://www.vitalsource.com (Links to an external site.)

Macrotrends. (2020). McDonald’s.  https://www.macrotrends.net/stocks/charts/MCD/mcdonalds/debt-equity-ratio (Links to an external site.)

SEC. (2020). McDonald’s Annual Financial Statements.  https://www.sec.gov/cgi-bin/viewer?action=view&cik=63908&accession_number=0000063908-20-000022&xbrl_type=v#