A company has made a profit for the year. Which of the following company actions will have no effect on its Leverage ratio compared to the start of the year?
a) It retains all its earning and uses the money to purchase new equipment
b) It issues (sells) new equity shares and uses the money to purchase equipment
c) It issues (sells) new equity shares and uses to the money to pay off exactly that amount in bank loans
d) It issues (sells) a bond and uses the money to pay off exactly that amount in bank loans
Solution
Leverage ratios assess the ability of a company to meet financial obligations. Leverage ratios are also called as long-term solvency ratios or capital structure ratios.
Most common types of Leverage ratios are,
Debt-Equity Ratio = Long term debt/Shareholders\' fund
= Total debt/Total Shareholders\' fund (Equity)
Debt to total capital ratio = Long term debt/Total capital
= (Long term debt+Current liabilities)/( Long term debt+Shareholder\'s fund)
If consider the option (d) It issues (sells) a bond and uses the money to pay off exactly that amount in bank loans
Here company is issuing bond to pay off exactly same amount of bank loans. This means that total debt is same even after the transaction as issuing bond is also one type of debt issuance.
So doing this will have no impact on leverage ratio.
.
A company has made a profit for the year- Which of the following compa.docx
1. A company has made a profit for the year. Which of the following company actions will have no
effect on its Leverage ratio compared to the start of the year?
a) It retains all its earning and uses the money to purchase new equipment
b) It issues (sells) new equity shares and uses the money to purchase equipment
c) It issues (sells) new equity shares and uses to the money to pay off exactly that amount in
bank loans
d) It issues (sells) a bond and uses the money to pay off exactly that amount in bank loans
Solution
Leverage ratios assess the ability of a company to meet financial obligations. Leverage ratios are
also called as long-term solvency ratios or capital structure ratios.
Most common types of Leverage ratios are,
Debt-Equity Ratio = Long term debt/Shareholders' fund
= Total debt/Total Shareholders' fund (Equity)
Debt to total capital ratio = Long term debt/Total capital
= (Long term debt+Current liabilities)/( Long term debt+Shareholder's fund)
If consider the option (d) It issues (sells) a bond and uses the money to pay off exactly that
amount in bank loans
Here company is issuing bond to pay off exactly same amount of bank loans. This means that
total debt is same even after the transaction as issuing bond is also one type of debt issuance.
So doing this will have no impact on leverage ratio.
