Question

The following table shows firms from different industries in the Australian stock market. Company Name Industry...

The following table shows firms from different industries in the Australian stock market.

Company Name

Industry

Life-cycle stage

Cash flows

Tech Ltd

Technology

Introductory

Highly Uncertain

Your Energy Ltd

Utility

Mature

Certain

Tech Adv Ltd

Technology

Growth

Uncertain

Which of the above firm(s) will be able to afford a high debt to equity ratio? Explain your answer.

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Answer #1

Your Energy Limited will be able to afford a high debt to equity ratio because to service debt fixed payments are required implying the firm should be able to generate sufficient cash flows. In case of other firms, the cash flows are uncertain hence there might be instances when the company is not able to service debt thus leading to insolvency/bankruptcy. Only in case of Your Energy, the cash flows are certain and it is in mature stage, and hence this can only afford high debt to equity ratio.

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