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Equity Multiplier

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Equity Multiplier Definition

Also known as the financial leverage or leverage ratio, the equity multiplier measures financial leverage, the amount of debt a company carries to operate its business. Analysts use the ratio to measure how efficiently a company uses debt to finance its assets. The ratio is calculated by dividing total assets by shareholders equity. In essence, the ratio compares the value of assets to the value of equity. A higher equity multiplier indicates higher financial leverage, which means the company is relying more on debt to finance its assets. The equity multiplier is an important component of the DuPont return on equity analysis.

Example 1:

Calculate the equity multiplier for Stevenson Steel, when:

  • Total asset value = $100 billion
  • Beginning equity = $40 billion
  • Net income for 2012 = $10 billion
  • Dividends paid during 2012 = $4 billion
  • Total equity = beginning equity + net income − dividends = $40 billion + $10 billion - $4 billion = $46 billion
  • Equity multiplier = Total asset value ÷ total equity = 100 ÷ 46 = 2.2

Example 2:

Find the equity multiplier for Michelson Sports Supply when:

  • Debt- to-equity ratio = 2
  • Assets-to-equity ratio = 3 Debt = assets – equity
  • Debt-to-equity ratio = (Assets − Equity) ÷ Equity = 2
  • Assets − equity = 2 x equity value Asset value = 3 x equity value
  • Equity multiplier = asset value ÷ equity value = 3.