Finance Formulas / July 14, 2018 / Cecelia Weiss
Stockholders' equity is often referred to as the book value of the company, and it comes from two main sources. The first source is the money originally and subsequently invested in the company. The second source consists of the retained earnings the company accumulates over time through its operations. In most cases, especially when dealing with companies that have been in business for many years, retained earnings is the largest component.
The PV, or present value, portion of the loan payment formula uses the original loan amount. The original loan amount is essentially the present value of the future payments on the loan, much like the present value of an annuity.
Given that the debtequity ratio measures a company’s debt relative to the total value of its stock, it is most often used to gauge the extent to which a company is taking on debt as a means of leveraging (attempting to increase its value by using borrowed money to fund various projects). A high debtequity ratio generally means that a company has been aggressive in financing its growth with debt. Aggressive leveraging practices are often associated with high levels of risk. This may result in volatile earnings as a result of the additional interest expense.
According to DuPont analysis, there are three major financial metrics drive return on equity (ROE): operating efficiency, asset use efficiency and financial leverage. Operating efficiency is represented by net profit margin or net income divided by average shareholders' equity. Asset use efficiency is measured by total asset turnover or the asset turnover ratio. Finally, financial leverage is analyzed through observation of changes in the equity multiplier.
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