Question 7.11: Evaluation of Solvency Ratios A credit analyst is evaluating......
Evaluation of Solvency Ratios
A credit analyst is evaluating the solvency of Alcatel-Lucent (Euronext Paris: ALU) as of the beginning of 2010. The following data are gathered from the company’s 2009 annual report (in € millions): (Table 1)
1 . A . Calculate the company’s financial leverage ratio for 2009.
B . Interpret the financial leverage ratio calculated in Part A.
2 . A . What are the company’s debt-to-assets, debt-to-capital, and debt-to-equity ratios for the two years?
B . Is there any discernable trend over the two years?
| 2009 | 2008 | |
| Total equity | 4,309 | 5,224 |
| Accrued pension | 5,043 | 4,807 |
| Long-term debt | 4,179 | 3,998 |
| Other long term liabilities* | 1,267 | 1,595 |
| Current liabilities* | 9,050 | 11,687 |
| Total equity + Liabilities (equals Total assets) | 23,848 | 27,311 |
| (Table 1) | ||
*For purposes of this example, assume that these items are non-interest bearing, and that long-term debt equals total debt. In practice, an analyst could refer to Alcatel’s footnotes to confirm details, rather than making an assumption.
1: (Amounts are millions of euro.)
A . Average total assets was (27,311 + 23,848)/2 = 25,580 and average total equity was (5,224 + 4,309)/2 = 4,767. Thus, financial leverage was 25,580/4,767 = 5.37.
B . For 2009, every €1 in total equity supported €5.37 in total assets, on average.
2: (Amounts are millions of euro.)
A . Debt-to-assets for 2008 = 3,998/27,311 = 14.64%
Debt-to-assets for 2009 = 4,179/23,848 = 17.52%
Debt-to-capital for 2008 = 3,998/(3,998 + 5,224) = 43.35%
Debt-to-capital for 2009 = 4,179/(4,179 + 4,309) = 49.23%
Debt-to-equity for 2008 = 3,998/5,224 = 0.77
Debt-to-equity for 2009 = 4,179/4,309 = 0.97
B . On all three metrics, the company’s leverage has increased. The increase in debt as part of the company’s capital structure indicates that the company’s solvency has weakened. From a creditor’s perspective, lower solvency (higher debt) indicates higher risk of default on obligations.