Your Firm has an established debt policy of 60 percent for all capital expenditures. What targeted value for the replacement viability ratio must be set?
To determine the targeted value for the replacement viability ratio, you need to understand what the replacement viability ratio is and how it relates to the debt policy.
The replacement viability ratio is a measure that indicates the firm's ability to repay its debt obligations. It compares the profits generated by the new capital investment to the debt used for financing that investment. A higher ratio indicates a better ability to repay debt.
Given that your firm has an established debt policy of 60 percent for all capital expenditures, it implies that the firm aims to finance 60 percent of the capital expenditure through debt. Therefore, the targeted value for the replacement viability ratio should be set sufficiently high to demonstrate the firm's ability to generate enough profits to cover the debt obligations.
While the specific targeted value for the replacement viability ratio may vary based on the firm's industry, financial condition, and risk appetite, a commonly used measure is a ratio above 1.0. This means that the firm's profits should be more than sufficient to cover the debt obligations associated with the capital investment.
So, in summary, to determine the targeted value for the replacement viability ratio, you need to ensure that the ratio is set above 1.0, indicating that the firm's profits are enough to cover the debt obligations resulting from the capital expenditure.
To determine the targeted value for the replacement viability ratio, we first need to understand the concept and formula of the replacement viability ratio.
The replacement viability ratio is a financial metric that calculates the percentage of funds available for capital expenditures that is allocated to replace existing assets. It indicates how well a company is managing its capital assets and demonstrates its commitment to maintaining and upgrading its equipment and infrastructure.
The formula for the replacement viability ratio is:
Replacement Viability Ratio = Capital Expenditures for Replacement / Total Capital Expenditures
Given that your firm has an established debt policy of 60 percent for all capital expenditures, it suggests that the debt portion should be 60 percent of the total capital expenditure. However, the replacement viability ratio focuses specifically on the capital expenditures allocated for replacement purposes.
To determine the targeted value for the replacement viability ratio, you need to establish the desired allocation of capital expenditure funds for replacement purposes. This value can be determined based on your firm's specific circumstances, objectives, and industry standards.
For example, if your firm wants to allocate 40 percent of the total capital expenditure for replacement purposes, the targeted value for the replacement viability ratio would be 40 percent. This means that 40 percent of the total capital expenditure budget is earmarked for replacing existing assets.
Ultimately, the specific targeted value for the replacement viability ratio will depend on your firm's financial strategy, investment priorities, and the need for asset replacement within your industry. It is a decision made by your firm's management based on various factors and considerations.