Equity Multiplier
What It Is:
The equity multiplier is a ratio used to determine the financial leverage of a company.
How It Works/Example:
The formula for the equity multiplier is:
Equity Multiplier = Total Assets / Total Stockholders' Equity
If company ABC has total assets of 20 units and total stockholders' equity of 4 units, its equity multiplier is 5 (20/4).
Alternatively, company XYZ has total assets of 10 units and total stockholders' equity of 5 units, its equity multiplier is 2 (10/5).
Since company ABC has a higher equity multiplier, it can be said to rely more heavily on debt in order to finance its assets.
Why It Matters:
Commonly employed to measure the extent to which a company finances its assets with debt, the equity multiplier is an important indicator of the financial health of a company: the higher the equity multiplier, the higher the level of financial leverage.
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Cached on May 23, 2012, 5:58 pm