Total Value of Equity, Essay Example

In the event the organization indicates a Debt ratio at D₁, it has suboptimal debt ratio. This can be explained to mean that the organization has no debt. Additionally, the organization appears successful and effective. Consequently, the possibility of a takeover is curtailed and discouraged.

Extreme liquidity in an organization cannot lead to a forced takeover. In most cases, what matters is the capability of the organization to cater for the expenses. Pressure will mount on the management if the firm continues to incur debts, instead of paying them. In such an event, the organization may experience a takeover, or face indefinite closure. In the event the company has excess liquidity, the best thing is to re-invest it in the organization or purchase additional debt.

The ultimate goal of any organization is to maximize the equity of the shareholders. In the event of an increased debt ratio, an increase in the market value of equity will be triggered. Investors with equity require some level of “leverage” (Debt finance) tin order to have access to increased chances and a high return rate. Debt is acquired to finance any form of expansion, the payment of debt remain fixed, and extra net income goes to the current equity holders. As a result, debt finance is likely to bring about chances of increased rate of return for the major equity investors while compared to the external equity finance as long as net operating finances remain high. In the same vein, an organization with 99% of debt connected to the assets and it happens that an unfortunate incidence occurs in the market, the organization may find it difficult to recover, and this may trigger bankruptcy and failure.