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Using the figures given below calculate the Debt/Equity ratio of SES Ltd for the years 2006 and 2007 - Leaving Cert Business - Question C(i) - 2009
Question C(i)
Using the figures given below calculate the Debt/Equity ratio of SES Ltd for the years 2006 and 2007. (Show your workings) | | 2006 | 2007 |... show full transcript
Worked Solution & Example Answer:Using the figures given below calculate the Debt/Equity ratio of SES Ltd for the years 2006 and 2007 - Leaving Cert Business - Question C(i) - 2009
Step 1
Calculate Debt/Equity Ratio for 2006
Answer
To calculate the Debt/Equity Ratio for 2006, we will use the formula:
ext{Debt/Equity Ratio} = rac{ ext{Debt Capital}}{ ext{Equity Capital}}Where:
- Debt Capital = Long Term Loans = 300,000
- Equity Capital = Ordinary Share Capital + Retained Earnings
- Equity Capital = 450,000 + 50,000 = 500,000
Now we can calculate:
ext{Debt/Equity Ratio} = rac{300,000}{500,000} = 0.6Step 2
Calculate Debt/Equity Ratio for 2007
Answer
For the year 2007, we use the same formula:
Where:
- Debt Capital = Long Term Loans = 364,000
- Equity Capital = Ordinary Share Capital + Retained Earnings
- Equity Capital = 450,000 + 70,000 = 520,000
The calculation is:
ext{Debt/Equity Ratio} = rac{364,000}{520,000} ext{, which simplifies to } 0.7Step 3
Comment on the significance of the trend in the Debt/Equity ratio over the two years for the existing shareholders.
Answer
The trend in the Debt/Equity Ratio from 0.6 in 2006 to 0.7 in 2007 indicates an increase in the company's reliance on debt.
This change should be considered by existing shareholders for several reasons:
-
Higher Interest Repayments: Increased debt levels may lead to higher interest repayments, which could reduce net profits.
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Profitability Risks: If profits fall, this increase could threaten the payment of dividends, particularly impacting incentive structures for existing shareholders.
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Investment Returns: The rising ratio suggests potential risks for investors. If the debt levels continue to increase, it may be harder for existing shareholders to see substantial returns on their investments.
In summary, shareholders need to monitor this trend carefully, as higher debt could signal financial strain, reducing overall profitability and returns.