Question

In 2018, Caterpillar Inc. had about 653 million shares outstanding. Their book value was $28.0 per share, and the market price was $157.30 per share. The company’s balance sheet shows that the company had $19.80 billion of long-term debt, which was currently selling near par value.

a. What was Caterpillar’s book debt-to-value ratio? (Do not round intermediate calculations. Enter your answer as a decimal rounded to 2 decimal places.)

b. What was its market debt-to-value ratio? (Do not round intermediate calculations. Enter your answer as a decimal rounded to 2 decimal places.)

c. Which measure should you use to calculate the company’s cost of capital?

Answer 1

A) - Book debt to value ratio = Book value of debt / Book value of debt + Book value of equity

Debt value = $19.80 billion

Equity value = Market price * No.of shares outstanding

= 28 * 653 = $18.284 billion

Book value of debt ratio = 19.80 / (19.80 + 18.284) = 0.519

B) Market debt to value ratio = Market value of debt / Market value of debt + equity value

Debt value = $19.80 billion (Market value = Book value because it is given that debt is selling at par)

Equity value = Market price * No.of shares outstanding

= 157.30 * 653 = $102.717 billion

Market value of debt ratio = 19.80 / (19.80 + 102.717) = 0.1616

C) We will use Market Value for calulating cost of capital because an investor will like to see current value of company which can be more appropriately gauged by rates prevailing in the market.