Question

Assuming That the Debt to Equity Ratio is 2 : 1, state giving reasons, which of the following transactions would  (i) increase; (ii) Decrease; (iii) Not alter Debt to Equity Ratio:

Answer 1

Let’s take Debt and Equity as Rs 2,00,000 and Rs 1,00,000

${\displaystyle \text{Debt- Equity Ratio}=\frac{\text{Debt}}{\text{Equity}}=\frac{200000}{100000}=2:1}$

(i) Issue of new shares for cash (say Rs 50,000)

Debt to Equity Ratio =${\displaystyle \frac{200000}{100000+50000}=1.33:1}$ (Decrease)

(ii) Conversion of debentures into equity shares (say Rs 50,000)

Debt to Equity Ratio =${\displaystyle \frac{200000}{100000+50000}=1.33:1}$ (Decrease)

(iii) Sale of a fixed asset at profit (say Rs 50,000 profit)

Debt to Equity Ratio = ${\displaystyle \frac{200000}{100000+50000}=1.33:1}$ (Decrease)

(iv) Purchase of fixed asset on long term payment basis (say Rs 50,000)

Debt to Equity Ratio =${\displaystyle \frac{200000+50000}{100000}=2.5:1}$ (Increase)

(v) Payment to creditors (say Rs 50,000)

Debt to Equity Ratio = ${\displaystyle \frac{200000}{100000}=2:1}$ (No change)