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Question
The debt equity ratio of M Ltd. is 2:1. State with reasons whether the following transaction will increase, decrease or not change the debt equity ratio :
- Obtained a loan from ICICI Bank ₹1,00,000 payable after 5 years.
- Purchased machinery for cash ₹1,50,000.
- Redeemed 9% debentures ₹1,00,000.
- Issued equity shares for purchase of machinery of ₹5,00,000 to the vendors.
Solution
Debt Equity Ratio = 2 : 1
Debt Equity Ratio =`"Debt"/"Equity" = (20,00,000)/(10,00,000)`[assumed figures]
- Loan from ICICI - ₹1,00,000
Increases as debts will increases `(21,00,000)/(10,00,000)= 2.1 :1` - Machinery purchased for cash ₹1,50,000
No change as, machinery is a fixed assets and cash is a current asset, then it will not change debt equity ratio. - Redeem 9% debentures of ₹1,00,000
Debt =20,00,000 - 1,00,000 = ₹19,00,000
New Ratio =`(19,00,000)/(10,00,000) = 19 :1`
Thus, Ratio will decrease. - Issue equity shares ₹5,00,000 for machinery
Equity = 10,00,000 + 5,00,000 = 15,00,000
New ratio =`(20,00,000)/(15,00,000)= 0.8 :1`
Equity will increase, therefore ratio will decrease.
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