Market Debt Ratio

Market debt ratio is a solvency ratio that measures the proportion of the book value of a company's debt to sum of the book of value of its debt and the market value of its equity.

Market debt ratio is a modification of the traditional debt ratio, which is the proportion of the book value of debt to sum of the book values of debt and equity of the company.

Market debt ratio measures the level of debt of a company relative to the current market value of the company and is potentially a better measure of solvency because market values are more relevant than book values.

Formula

 Market Debt Ratio = Total Liabilities Total Liabilities + Market Value of Equity

Market Value of Equity = Current Share Price × Number of Shares Outstanding

Number of Shares Outstanding = Total Number of Shares Issued − Treasury Shares

For companies with debt that trades in secondary markets, including the market value of debt can further refine the market debt ratio.

Example

Calculate the market debt ratio for McGraw Hill Financial Inc. (NYSE: MGHF) using the following data from 31 December 2012 and compare it with the debt ratio for the same period.

 Total Liabilities (USD In million) 5,475 Total shareholders' equity (USD in million) 767 Share price (USD) 54.67 Number of outstanding shares (in million) 271

Solution

Market value of equity = $54.67 × 271 million =$14,816 million

Market debt ratio = $5,475 million/($5,475 million + $14,816 million) = 26.98% Debt ratio =$5,475 million /($5,475 million+$767 million) = 87.7%

In this situation the traditional debt ratio and the market debt ratio both suggest conflicting possibilities. Debt ratio of 87.7% is quite alarming as it means that for roughly $9 of debt there is only$1 of equity and this is very risky for the debt-holders. Market debt ratio of 26.98% is quite safe on the other hand, as it suggests that the company is in a very comfortable solvency situation.

The extremely high debt ratio might be due to excessive adjustments to shareholders' equity resulting in very low equity at the period end and hence the very high debt ratio. Market debt ratio on the other hand takes into account the market valuation of the company and should be given more weight.

Written by Obaidullah Jan, ACA, CFAhire me at