Good Morning JBE,
Your response in point #1 underscores the need for doing your own research. For example, you list auto manufacturers as having the highest debt/equity ratio. But an examination of GM reveals that the definition of debt depends on the industry. For example, equity at the end of 1997 stood at $17,728 MM, and long term debt (narrowly-defined) was $5,491 yielding a ratio of .309. When capitalized leases are added ($185) the ratio rises to 0.32. GM is conservative compared to many companies and capitalizes its pension and post retirement costs which add another $42,659MM to long-term liabilities. Inclusion of these items raises the debt/equity ratio to 2.76. However, many industries do not capitalize these items, so it is an error to compare these items across industries. I guess what I'm suggesting is that those debt:equity ratios that you quoted may in reality be long-term liabilities:equity.
Your second point is correct, and in fact many people use liabilities:equity. However, using a free cash flow projection takes care of this because current liabilities are always expense items.
Remember, the idea of including a sinking fund in free cash flow is to include the long-term liabilities in that cash flow statement.
Your third point muddies the water a bit (no offense intended). The idea is to annualize the cash flows based on known operations. There are certain assumptions implicit in this approach. They are that those capital expenditures will be ongoing, and their maturity coincides with the lifetime of the asset. Thus, if a drilling rig costs $250MM to build and it has an expected lifetime of twenty years it will be financed with a twenty year obligation. So what we do is annualize the capital cost. If the interest rate on a twenty year obligation is 7%, then we expect to pay $23.6MM annually in our sinking fund for that rig. Similarly, we expect repair and refurbishment costs to persist.
So, your fourth point is really a weakness. You should calculate these things yourself because of inconsistencies in the way companies report financial information, and errors are common in the way financial services report data.
Question #5. (Why do I feel like I'm writing test answers in a blue book?) I think Mr. G. ought to use Value Line and rely on their research. It is just too difficult to wade through a lot of these data without specific accounting information. And it becomes doubly hard whenever there is a change in accounting practices.
I haven't read "Cash Flow and Security Analysis", but will try to get a copy from the library. The "bible" in the field is Grant and Iverson's Engineering Economy
TTFN,
CTC |
