{"id":30879,"date":"2025-02-12T09:40:45","date_gmt":"2025-02-12T14:40:45","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&#038;p=30879"},"modified":"2025-04-02T18:52:41","modified_gmt":"2025-04-02T23:52:41","slug":"debt-to-equity-ratio","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/debt-to-equity-ratio\/","title":{"rendered":"The Debt-to-Equity Ratio in Valuation and Financial Modeling: Quick Risk Assessment?"},"content":{"rendered":"<blockquote><p><strong>Debt-to-Equity Ratio Definition:<\/strong> The Debt-to-Equity Ratio equals a company\u2019s Total Debt \/ Total Common Shareholders\u2019 Equity and, depending on the context, may be based on either the <em>book values<\/em> or the <em>market values<\/em> of these items; it measures the company\u2019s overall risk from leverage and can indicate how expensive its next Debt issuance might be.<\/p><\/blockquote>\n<p>Many sources online present the \u201ctextbook\u201d definition of the Debt-to-Equity Ratio:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30880 size-full\" title=\"Debt-to-Equity Ratio\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093604\/01-Debt-to-Equity-Ratio.jpg\" alt=\"Debt-to-Equity Ratio\" width=\"1486\" height=\"296\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093604\/01-Debt-to-Equity-Ratio.jpg 1486w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093604\/01-Debt-to-Equity-Ratio-300x60.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093604\/01-Debt-to-Equity-Ratio-1024x204.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093604\/01-Debt-to-Equity-Ratio-768x153.jpg 768w\" sizes=\"(max-width: 1486px) 100vw, 1486px\" \/><\/p>\n<p>While this version is useful for <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/\" target=\"_blank\" rel=\"noopener\">financial statement analysis<\/a>, it\u2019s too limited because this ratio might also be based on the <em>market values<\/em> of Debt and Equity, i.e., how much other investors might be willing to pay for them.<\/p>\n<p>The <em>market value<\/em> version is more common in valuation and <a href=\"https:\/\/mergersandinquisitions.com\/dcf-model\/\" target=\"_blank\" rel=\"noopener\">DCF analysis<\/a> for calculating the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/discount-rate\/\" target=\"_blank\" rel=\"noopener\">Discount Rate<\/a>, or <a href=\"https:\/\/mergersandinquisitions.com\/wacc-formula\/\" target=\"_blank\" rel=\"noopener\">WACC<\/a>:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30881 size-full\" title=\"Debt-to-Equity Ratio - Market Values\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093629\/02-Debt-to-Equity-Ratio-Market.jpg\" alt=\"Debt-to-Equity Ratio - Market Values\" width=\"1490\" height=\"288\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093629\/02-Debt-to-Equity-Ratio-Market.jpg 1490w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093629\/02-Debt-to-Equity-Ratio-Market-300x58.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093629\/02-Debt-to-Equity-Ratio-Market-1024x198.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093629\/02-Debt-to-Equity-Ratio-Market-768x148.jpg 768w\" sizes=\"(max-width: 1490px) 100vw, 1490px\" \/><\/p>\n<p>In both cases, the Debt-to-Equity Ratio indicates a company\u2019s <strong>risk from leverage<\/strong>, i.e., the extra risk it assumes by using Debt to fund its operations.<\/p>\n<p>If a company uses too much Debt, it risks defaulting on its interest payments and principal repayments.<\/p>\n<p>But even without a default, there is still additional risk because this Debt Service might \u201ccrowd out\u201d the company\u2019s funds available for growth and maintenance and limit the company\u2019s potential.<\/p>\n<p>In extreme cases, companies with high Debt-to-Equity Ratios could even be at heightened risk for bankruptcy.<\/p>\n<h3><strong>Files &amp; Resources:<\/strong><\/h3>\n<ul>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Financial-Statement-Analysis\/Debt-to-Equity\/101-08-BLDR-Analysis.xlsx\" target=\"_blank\" rel=\"noopener\">Debt-to-Equity Ratio Analysis for Builders FirstSource (Historical Statements and Simple DCF) (XL)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Financial-Statement-Analysis\/Debt-to-Equity\/101-08-Enterprise-Value-WACC.xlsx\" target=\"_blank\" rel=\"noopener\">Debt-to-Equity Ratio Impact on Implied Enterprise Value in a DCF (XL)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Financial-Statement-Analysis\/Debt-to-Equity\/101-08-Debt-to-Equity-Ratio-Slides.pdf\" target=\"_blank\" rel=\"noopener\">Debt-to-Equity Ratio \u2013 Slides (PDF)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Financial-Statement-Analysis\/Debt-to-Equity\/101-08-BLDR-10-K.pdf\" target=\"_blank\" rel=\"noopener\">Builders FirstSource \u2013 10-K (PDF)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Financial-Statement-Analysis\/Debt-to-Equity\/101-08-BLDR-10-Q.pdf\" target=\"_blank\" rel=\"noopener\">Builders FirstSource \u2013 10-Q (PDF)<\/a><\/li>\n<\/ul>\n<h3><strong>Video Table of Contents:<\/strong><\/h3>\n<ul>\n<li><strong>0:00:<\/strong> Introduction<\/li>\n<li><strong>2:59:<\/strong> Part 1: Basic Calculations<\/li>\n<li><strong>4:57:<\/strong> Part 2: What is a \u201cGood\u201d Debt-to-Equity Ratio?<\/li>\n<li><strong>6:30:<\/strong> Part 3: Debt to Equity in Valuation<\/li>\n<li><strong>10:38:<\/strong> Part 4: Debt to Equity in Credit Analysis<\/li>\n<li><strong>13:22:<\/strong> Recap and Summary<\/li>\n<\/ul>\n<h2><strong>How to Calculate the Debt-to-Equity Ratio<\/strong><\/h2>\n<p>To calculate the Debt-to-Equity Ratio in the context of a <a href=\"https:\/\/mergersandinquisitions.com\/3-statement-model\/\" target=\"_blank\" rel=\"noopener\">3-statement model<\/a> or credit analysis, simply take the company\u2019s Debt and divide it by its Common Shareholders\u2019 Equity.<\/p>\n<p>You do <em>not<\/em> use its Total Equity, as this number might also include Preferred Stock and Noncontrolling Interests, which are separate items (see our <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/statements-of-owners-equity\/\" target=\"_blank\" rel=\"noopener\">Statement of Owners\u2019 Equity tutorial<\/a> for more).<\/p>\n<p>Here\u2019s an example for Builders FirstSource in the building materials industry:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30882 size-full\" title=\"Debt-to-Equity Ratio - Calculations\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation.jpg\" alt=\"Debt-to-Equity Ratio - Calculations\" width=\"2117\" height=\"802\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation.jpg 2117w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation-300x114.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation-1024x388.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation-768x291.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation-1536x582.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093658\/03-Debt-to-Equity-Ratio-Calculation-2048x776.jpg 2048w\" sizes=\"(max-width: 2117px) 100vw, 2117px\" \/><\/p>\n<p>Some sources suggest that this ratio should be based on Total Liabilities \/ Common Shareholders\u2019 Equity, but that is not the traditional definition because \u201cTotal Liabilities\u201d includes much more than just Debt!<\/p>\n<p>Including Liabilities such as Accounts Payable and Accrued Expenses in this number is silly because they are short-term items that do not bear interest.<\/p>\n<p>Therefore, they do not impose the same default or bankruptcy risk as Debt; unless something highly unusual happens, companies cycle through these items regularly.<\/p>\n<p>You could <em>potentially<\/em> include other interest-bearing Liability and Equity line items in the \u201cDebt\u201d balance here, such as Preferred Stock or Finance Lease Liabilities, but it becomes a different metric with that approach.<\/p>\n<p>In a valuation context, you normally use the Debt-to-Equity Ratio based on the market values to un-lever and re-lever Beta in the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/discounted-cash-flow-analysis-dcf\/wacc-formula\/\" target=\"_blank\" rel=\"noopener\">WACC calculation<\/a>:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30883 size-full\" title=\"Debt-to-Equity Ratio - Usage in Unlevering Beta\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta.jpg\" alt=\"Debt-to-Equity Ratio - Usage in Unlevering Beta\" width=\"2428\" height=\"908\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta.jpg 2428w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta-300x112.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta-1024x383.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta-768x287.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta-1536x574.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093719\/04-Unlevered-Beta-2048x766.jpg 2048w\" sizes=\"(max-width: 2428px) 100vw, 2428px\" \/><\/p>\n<p><strong>Unlevered Beta<\/strong> = Levered Beta \/ (1 + Debt \/ Equity * (1 \u2013 Tax Rate) + Preferred \/ Equity)<\/p>\n<p><strong>Re-Levered Beta <\/strong>= Unlevered Beta * (1 + Debt \/ Equity * (1 \u2013 Tax Rate) + Preferred \/ Equity)<\/p>\n<p>As the subject company\u2019s Debt-to-Equity Ratio increases, its Re-Levered Beta increases, so its Cost of Equity goes up.<\/p>\n<p>Its Cost of Debt also starts to increase.<\/p>\n<p><em>Initially<\/em>, if the company is at a moderate Debt level, its WACC might fall because Debt is still cheaper than Equity.<\/p>\n<p>But above a certain Debt level, WACC starts to rise, reflecting the added risk from leverage.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h2><strong>Interpretation: What is a \u201cGood\u201d Debt-to-Equity Ratio?<\/strong><\/h2>\n<p>While it\u2019s tempting to say that \u201clower is better\u201d and \u201chigher is worse\u201d with this ratio, that\u2019s not quite how it works.<\/p>\n<p>Generally, it\u2019s best if a company\u2019s Debt-to-Equity Ratio is close to <strong>the levels of its peer companies<\/strong> (i.e., the set used in a <a href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/comparable-company-analysis-cca\/\" target=\"_blank\" rel=\"noopener\">comparable company analysis<\/a>).<\/p>\n<p>For example, you can see the range of values for the Builders FirstSource [BLDR] peer companies below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30884 size-full\" title=\"Debt-to-Equity Ratio for Comparable Companies\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps.jpg\" alt=\"Debt-to-Equity Ratio for Comparable Companies\" width=\"2116\" height=\"590\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps.jpg 2116w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps-300x84.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps-1024x286.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps-768x214.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps-1536x428.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093746\/05-Debt-to-Equity-Ratio-Comps-2048x571.jpg 2048w\" sizes=\"(max-width: 2116px) 100vw, 2116px\" \/><\/p>\n<p>These calculations are based on the market values of Debt and Equity for each company, and they tell us that BLDR\u2019s leverage is close to the median of the set.<\/p>\n<p>If BLDR had a much lower Debt-to-Equity Ratio, such as 5%, that wouldn\u2019t necessarily be positive.<\/p>\n<p>Since Debt is cheaper than Equity, it generally <em>benefits<\/em> companies to use Debt up to a reasonable level because it provides cheaper financing for their operations.<\/p>\n<p>So, with a Debt-to-Equity Ratio this low, BLDR might be poorly optimized.<\/p>\n<p>If the Debt-to-Equity Ratio is <em>too high<\/em>, such as 60% here, that is a <strong>negative sign<\/strong> because it means the company is assuming far too much credit risk.<\/p>\n<p>A company with a ratio this high will almost certainly have to pay a premium to issue Debt in the future based on the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/debt-equity\/yield-to-maturity\/\" target=\"_blank\" rel=\"noopener\">YTM of bond issuances<\/a>.<\/p>\n<p>If you calculate this ratio based on the <strong>book values<\/strong> of these items, you can expect to get much higher percentages because the book value of Equity is almost always much lower than a company\u2019s Equity Value or Market Cap.<\/p>\n<p>Once again, though, <strong>comparability<\/strong> is king.<\/p>\n<p>If you calculate the ratio this way, also do so this way for the peer companies and make the comparison based on the book values:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30885 size-full\" title=\"Debt-to-Equity Ratio for Comparable Companies (Book and Market Values)\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps.jpg\" alt=\"Debt-to-Equity Ratio for Comparable Companies (Book and Market Values)\" width=\"2282\" height=\"847\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps.jpg 2282w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps-300x111.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps-1024x380.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps-768x285.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps-1536x570.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093809\/06-Debt-to-Equity-Ratio-Book-Market-Comps-2048x760.jpg 2048w\" sizes=\"(max-width: 2282px) 100vw, 2282px\" \/><\/p>\n<h2><strong>How Does the Debt-to-Equity Ratio Affect Credit Analysis?<\/strong><\/h2>\n<p>In credit analysis, the Debt-to-Equity Ratio is just one factor influencing a company\u2019s profile and potential credit rating.<\/p>\n<p>Lenders also look at metrics like the Leverage Ratio (Debt \/ EBITDA), Interest Coverage Ratio (EBITDA \/ Interest), <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/liquidity-ratios\/\" target=\"_blank\" rel=\"noopener\">Liquidity Ratio<\/a>, and many others to judge a company.<\/p>\n<p><a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/balance-sheet\/\" target=\"_blank\" rel=\"noopener\">Balance Sheet<\/a>-based metrics like the Debt-to-Equity Ratio are <em>less important<\/em> than metrics involving the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/income-statement\/\" target=\"_blank\" rel=\"noopener\">Income Statement<\/a> and <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/cash-flow-statement\/\" target=\"_blank\" rel=\"noopener\">Cash Flow Statement<\/a> because lenders care mostly about a company\u2019s ability to <em>service<\/em> its Debt.<\/p>\n<p>In other words, if a company\u2019s Debt \/ Equity is on the high side, that doesn\u2019t necessarily matter if the company still has a reasonable Debt \/ EBITDA and EBITDA \/ Interest.<\/p>\n<p>Debt \/ Equity may play more of a role in financial statement analysis because an above-normal number could inflate a company\u2019s <a href=\"https:\/\/breakingintowallstreet.com\/kb\/financial-statement-analysis\/return-on-equity-roe\/\" target=\"_blank\" rel=\"noopener\">Return on Equity (ROE)<\/a> and other Returns-based metrics.<\/p>\n<p>Here\u2019s an example of what might happen when a company\u2019s Debt-to-Equity Ratio increases:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30887 size-full\" title=\"Debt and Return on Equity (ROE)\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity.jpg\" alt=\"Debt and Return on Equity (ROE)\" width=\"2125\" height=\"1672\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity.jpg 2125w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity-300x236.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity-1024x806.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity-768x604.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity-1536x1209.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093925\/08-Debt-Return-on-Equity-2048x1611.jpg 2048w\" sizes=\"(max-width: 2125px) 100vw, 2125px\" \/><\/p>\n<p>Note that, as stated in the image, this scenario is a bit unrealistic because the company&#8217;s Interest Rate on Debt would almost certainly change if it went from 20% to 50% Debt \/ Total Capital.<\/p>\n<p>So, the ROE could still increase, but would probably not to the extent shown here.<\/p>\n<h2><strong>How Does the Debt-to-Equity Ratio Affect Valuation?<\/strong><\/h2>\n<p>In a DCF analysis based on <a href=\"https:\/\/breakingintowallstreet.com\/kb\/discounted-cash-flow-analysis-dcf\/unlevered-free-cash-flow\/\" target=\"_blank\" rel=\"noopener\">Unlevered FCF<\/a>, the company\u2019s capital structure still factors in because it affects the Discount Rate.<\/p>\n<p>You can see a simple example of how higher Debt levels affect WACC below (from the sample Excel file here):<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-30886 size-full\" title=\"Debt-to-Equity Ratio and WACC Impact\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093828\/07-Debt-to-Equity-Ratio-WACC.jpg\" alt=\"Debt-to-Equity Ratio and WACC Impact\" width=\"1506\" height=\"864\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093828\/07-Debt-to-Equity-Ratio-WACC.jpg 1506w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093828\/07-Debt-to-Equity-Ratio-WACC-300x172.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093828\/07-Debt-to-Equity-Ratio-WACC-1024x587.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/02\/12093828\/07-Debt-to-Equity-Ratio-WACC-768x441.jpg 768w\" sizes=\"(max-width: 1506px) 100vw, 1506px\" \/><\/p>\n<p>As the Debt-to-Equity Ratio increases, the company\u2019s Cost of Equity and Cost of Debt both increase, and past a certain level, WACC also starts to increase.<\/p>\n<p>Therefore, the company\u2019s implied value from the DCF <em>increases<\/em> up to a certain Debt-to-Equity Ratio but then <em>decreases<\/em> above that level.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The Debt-to-Equity Ratio equals a company\u2019s Total Debt \/ Total Common Shareholders\u2019 Equity and, depending on the context, may be based on either the book values or the market values of these items; it measures the company\u2019s overall risk from leverage and can indicate how expensive its next Debt issuance might be.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-30879","biws_kb","type-biws_kb","status-publish","hentry","kb_category-financial-statement-analysis"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/30879","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=30879"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}