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6. (i) Explain why a business would calculate the Debt / Equity Ratio - Leaving Cert Business - Question 6 - 2004
Question 6
6. (i) Explain why a business would calculate the Debt / Equity Ratio. (ii) Calculate the Debt / Equity Ratio for the year 2003: _____; Show all workings.
Worked Solution & Example Answer:6. (i) Explain why a business would calculate the Debt / Equity Ratio - Leaving Cert Business - Question 6 - 2004
Step 1
Explain why a business would calculate the Debt / Equity Ratio.
Answer
A business calculates the Debt / Equity Ratio to assess its financial leverage and stability.
This ratio indicates the relationship between the company's total debt and its equity capital, allowing stakeholders to evaluate how much of the company is financed by debt compared to its own funds. High levels of debt suggest higher financial risk as it can lead to increased interest payments, which could impact profits available for distribution to shareholders. Therefore, understanding this ratio helps in making informed decisions regarding the firm's financial structure and its ability to raise future funds.
Step 2
Calculate the Debt / Equity Ratio for the year 2003:
Answer
To calculate the Debt / Equity Ratio, we use the following formula:
Step 1: Identify total debt and total equity from the data provided:
- Long Term Loans: 100,000
- Overdrafts: 15,000
Total Debt = 100,000 + 15,000 = 115,000
Step 2: Identify total equity:
- Ordinary Share Capital: 50,000
- Reserves: 25,000
Total Equity = 50,000 + 25,000 = 75,000
Step 3: Substitute values into the formula:
Thus, the Debt / Equity Ratio for the year 2003 is 1.53:1.