Learn Debt-to-Equity & ROE with Real-Life Cases - Samosa Shop to Stock Market

Debt-to-Equity & ROE Simplified: Real-Life Case Studies

Tamilini: "Hey Parkavi, I need to understand the details of this debt-to-equity ratio. What’s the difference between companies that take bank loans and those that sell shares?"

Parkavi: "Let me explain it with the example of a samosa shop. We’ll look at two cases:

1. What happens if a bank loan is taken?

2. What happens if shares are given?"

Case 1 – Debt from Bank Loan

Parkavi:

Debt-to-Equity Ratio Calculation

"Imagine you are the owner of a samosa shop. You already have ₹1,00,000 in equity (personal investment). Now, you take a loan and borrow ₹50,000."

Step-by-Step Impact:

1. Debt-to-Equity Ratio Calculation: D/E = ₹50,000 ÷ ₹1,00,000 = 0.5 "This means, for every ₹1 equity, 50 paise is debt."

2. Interest Expense: "Assume the loan interest is 10% yearly. Interest expense = ₹50,000 × 10% = ₹5,000."

3. Profit After Tax (PAT): "Shop profit is ₹20,000. After deducting interest: Net Profit = ₹20,000 - ₹5,000 = ₹15,000. ROE Calculation: ROE = ₹15,000 ÷ ₹1,00,000 = 15%."

Advantages of D/E:

• Borrowing increases growth opportunities.

• Leverage helps in business expansion.

Disadvantages of D/E:

• High debt increases interest burden.

• Risk of default during bad times.

Tamilini: "Oh! Taking a bank loan means paying interest, which reduces ROE!"

Parkavi: "Exactly! But the advantage of debt is that you don’t dilute ownership. The shop remains under your control."

Case 2 – Debt from Investors (Equity Financing)

Parkavi:

Debt-to-Equity Ratio Calculation

"Now, let’s say instead of taking a loan, you sell shares in your shop and raise ₹50,000.

Now, you and your investor share profit equally (50:50). No loan, no interest expense."

Step-by-Step Impact:

1. Debt-to-Equity Ratio Calculation: "Now your shop has no debt, so: D/E = ₹0 ÷ ₹1,50,000 = 0 (No debt)."

2. Profit Sharing: "Shop profit is again ₹20,000. Since you split it with investors: Your Share = ₹10,000 Investor’s Share = ₹10,000."

3. ROE Calculation: "Your equity contribution is still ₹1,00,000. ROE = ₹10,000 ÷ ₹1,00,000 = 10%. Compared to the loan case, ROE drops further."

Advantages of ROE:

• High ROE shows efficient management.

• Indicates good shareholder returns.

Disadvantages of ROE:

• Too high ROE may indicate high debt.

• Does not consider market conditions.

Tamilini: "The higher ROE with a loan is because you maintain control!"

Parkavi: "Correct! The main disadvantage of equity financing is that it dilutes ownership. An investor in your samosa shop may interfere with your decisions."

Case Studies – Indian Companies

Parkavi:

Debt-to-Equity and ROE in the Stock Market

"Let’s see how Debt-to-Equity and ROE are used in the stock market:

Debt-to-Equity Ranges:

• Low D/E (0-0.5): Minimal debt, stable companies.

• Moderate D/E (0.5-1.0): Balanced debt and equity.

• High D/E (Above 1.0): High debt, potential risk.

ROE Ranges:

• Low ROE (Below 10%): Poor returns or inefficiencies.

• Moderate ROE (10%-20%): Average returns, decent management.

• High ROE (Above 20%): Strong returns, efficient management.

Infosys Stock Analysis

Debt-to-Equity Ratio of Infosys

• Debt-to-Equity = 0.08 (Minimal debt).

ROE of Infosys

• ROE = 20% (Efficient management). This means Infosys is a safe choice for long-term investors."

Tata Motors Stock Analysis

Debt-to-Equity Ratio of Tata Motors

• Debt-to-Equity = 2.5 (High debt).

ROE of Tata Motors

• ROE = -2% (Loss-making). Investors should be cautious, especially in uncertain markets."

Summary & Key Takeaways

Tamilini: "So, Parkavi, the advantage of debt is boosting growth, but it needs to be managed. The disadvantage of equity is diluting ownership!"

Parkavi: "Exactly! By checking a company’s D/E and ROE ratios, we can make safer decisions. Analyze financials to find low debt and high ROE like Infosys!"

Call-to-Action (CTA)

Parkavi: "If you found this video useful, like, share, and subscribe to the @ParkaviFinance channel! We’ll cover stock market basics in the next video!"

Tamilini: "Thank you, viewers! Bye for now!"

Debt-to-Equity Ratio (D/E) and Return on Equity (ROE) are key financial ratios that help investors evaluate a company's financial health. This blog simplifies these concepts with a Samosa Shop business example, explaining how bank loans vs equity financing impact company growth and investor returns.

📌 What You’ll Learn:
✅ Debt-to-Equity Ratio Meaning & Formula 📊
✅ ROE (Return on Equity) Calculation 🔢
✅ Bank Loan vs Equity Financing – Which is Better? 💰
✅ Infosys & Tata Motors Stock Market Case Study 📈
✅ Smart Investing Tips – How to Analyze Stocks Using Financial Ratios 🚀

Understanding these financial metrics helps investors pick the right stocks and make better financial decisions. Read till the end for expert insights!

📌 Explore More on Parkavi Finance for Financial Education!

🔔 Subscribe to @ParkaviFinance for stock market updates!

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