The Capital Structure Decision and the Cost of Capital - Research Paper Example

Debt to equity ratio shows how well creditors are protected. From the calculated ratios, the following inferences can be made.
The debt/equity ratio based on long-term liability is quite low and the company Nvidia is going quite safe so far as long-term liability is concerned. It can also be gauged from this ratio that the company is quite conservative in exploiting the long-term debt for the growth of the company.
The debt/equity ratio based on short-term liability is within the limits of a healthy company.

The debt/equity ratio at 41.2% is fairly within industry standards. This is also an indication that the company relies more on stakeholders’ funds than on creditors or outside debt. This also indicates that the company is not very aggressive in leveraging its equity. This goes in favor of the company in difficult (recessionary) market conditions but as market conditions improve and the company is in a position to enter new growth trajectories, Nvidia should use more debt to finance its expansion needs instead of equity. That will help the company to enhance its equity valuation in the market.

It is seen that the debt-equity ratio of Intel and Nvidia are more or less in the same range but AMD is operating on very high debt. The company is aggressively following the policy of high leveraging. High leveraging is double-edged. During the favorable time, if the company can successfully service its debt then any earning above its cost of debt will enhance the earnings per share of the company enormously for the simple reason that the company is operating with high leverage. The reverse is also true, during the bad phase and recessionary condition, if the company cannot earn enough to pay for its debt then the burden will be insurmountable to push the company into the red.
The low debt-equity ratio in the case of Intel could be due to the reason that the company is generating enough cash year after year through internal accruals, which can meet its financial needs. Thus, the company does not have any need to borrow from the market keeping its debt at a reasonable level. (Crfonline.org)

Thus, it is quite clear that the debt-equity and debt ratios of the companies indicate how the company has raised its financial needs–from the debt or equity route. This also tells us about the nature of the company that whether the company is aggressive with high leveraging or the company believes in moderate or low leveraging to keep its operating risks at a low level. In fact, different companies have different philosophies with regard to their debt and equity proportions. Merits and demerits of such selection entirely depend upon the market situations with high risk and high reward for high debt-financed companies. It should be viewed differently depending upon whether one is a creditor or a stakeholder.