value of debt and equity in early 2005, as shown in the
following table:
ManyanalystsinEuropeandLatinAmericaprefertosubtract
thecashfrom thegross debttoarriveatanetdebtfigure.
Whilethereisnoconceptualproblemwiththisapproach,you
should remain consistent. Consider the cost of capital
computation for Embraer. First, to make the levered beta
calculationforEmbraer,wewouldusethenetdebt-to-equity
ratio for the company. The net debt is computed by
subtractingEmbraer’scashbalanceof2,320millionBRfrom
its gross debt of 1,953 million BR, yielding a net
debt-to-equity (D/E) ratio of −3.32%.
Thecostofequityismuchlower,usingthenetdebt-to-equity
ratio,butthiswillbecompensatedfor(atleastpartially)when
weusethenetdebt-to-capitalratioof−3.43%tocomputethe
cost of capital.
Notice that the cost of capital using the net debtratio is
differentfromtheonecomputedusingthegrossdebtratio.
Thereasonliesinanimplicitassumptionthatwemakewhen