What is a Debt Ratio?

Problem 1 

Debt ratio is computed as the debt in total divided by the assets in total. The calculations of the debt ratio are computed to determine the debt proportion within the company. Therefore, the company can know what debts they have within their financial statements. 

Debt-to-equity ratio is computed by the equity dividing the debt. The computations are made to determine both the equity and the total debt proportions (Davies & Crawford, 2005). Hence, it is very essential to have a correct debt maintenance with the company’s equity mix. 

Equity multiplier is computed by division of the total assets using the total equity. 

Qn. Calculate the debt ratio. (Round your answers to 2 decimal places.) 

LotsofDebt, Inc 

Debt ratio = Overall debt / Overall assets 

Debt ratio = $29 million / $30 million 

Debt ratio = 0.9666666 

Debt ratio = 0.9667 or as a percentage, 96.67% 

LotsofEquity, Inc 

Debt ratio = Total debt / Total assets 

Debt ratio = $1 million / $30 million 

Debt ratio = 0.033333, Hence, Firm LOD has debt ratio as 3.33% 

Qn. Calculate the equity multiplier. (Round your answers to 2 decimal places.) 

LotsofDebt, Inc 

“ Equity multiplier = Total assets / Total equity” 

Equity multiplier = $30 million / $1 million 

Equity multiplier = 30 times 

LotsofEquity, Inc 

“ Equity multiplier = Total assets / Total equity” 

Equity multiplier = $30 million / $29 million 

Equity multiplier = 1.03448275862 

Equity multiplier = 1.034 times (to 2 dps) 

Qn. Calculate the debt-to-equity. (Round your answers to 2 decimal places.) 

LotsofDebt, Inc 

“ Debt-to-equity = Total debt / Total equity” 

Debt-to-equity = $29 million / $1 million 

Debt-to-equity =29 times 

LotsofEquity, Inc 

“ Debt-to-equity = Total debt / Total equity” 

Debt-to-equity = $1 million / $29 million 

Debt-to-equity =0.0344827586 

Debt-to-equity =0.034 times 

Problem 2 

How many days did Tater and Pepper’s inventory stay on the premises? (Use 365 days a year. 

Round your answer to 2 decimal places.) 

Solution 

Days on the inventory = (365 days * $5.6 million) / $23 million 

Days on the inventory = 88.8696 

Days on the inventory = 88.87 days 

Qn. How many times per year did Tater and Pepper’s inventory turnover? (Round your answer to 2 decimal places.) 

Solution 

Inventory turnover times = $23 million / $5.6 million 

Inventory turnover times = 4.10714285714 

Hence, the inventory times to 2 dps is 4.11 times. 

Problem 3 

What is the sustainable growth rate? (Do not round intermediate calculations. Round your 

answer to 2 decimal places.) 

Solution 

The following information has been provided, 

ROE = 17.5% 

Dividend payout ratio = 20% 

Retention ratio = 1 - dividend payout ratio 

Retention ratio = 1 – (20/100) 

Retention ratio = 1 – 0.20 = 0.80 

Therefore, the sustainable growth rate = [Retention ratio * ROE] / [1- (Retention ratio * ROE)] 

The sustainable growth rate = [0.8 * 0.175] / [1 – (0.8 * 0.175)] 

The sustainable growth rate = 0.14 / [1 – 0.14] 

The sustainable growth rate = 0.14 / 0.86 

The sustainable growth rate = 0.1627906976744 

The sustainable growth rate = 16.28% (to 2 dps) 

Problem 4 

Liquidity ratios are used in the measure of how the current liabilities and assets relate of a given firm. The ratios help in provision of a company with insight on its debt obligations and their safety margin through various calculations on the three existent ratios- quick, current and cash flow ratios (Hoyle, Schaefer & Doupnik, 2015). Conversion into cash is easier for the current assets under one year while current liabilities need to be paid off under a single year period. The main liquidity ratios that are needed in the evaluation process of the financial statements are the current ratio, the cash and quick ratios. The following information has been provided; 

Cash and marketable securities = $400,000, 

Accounts receivable = $1,200,000, 

Inventory = $2,100,000, 

Accrued wages and taxes = $500,000, 

Accounts payable =$800,000, 

Notes payable = $600,000. 

Hence, the calculation of the current assets is computed as: 

“ Current assets = Accounts receivable + Cash and marketable securities + Inventory” 

Current assets = $1,200,000 + $ 400,000 + $ 2,100,000 

Current assets = $3,700,000 

Current liabilities = Accounts payable + Accrued taxes and wages + Notes payable 

Current liabilities = $800,000 + $500,000 + $600,000 

Current liabilities = $1,900,000 

Calculating PattyCake’s current ratio is thus: 

“ Current ratio = Current assets / Current liabilities” 

Current ratio = $3,700,000 / $1,900,000 

Current ratio = 1.95 times 

Quick ratio is calculated as follows: 

Quick ratio = (Current assets - Inventory) / Current liabilities 

Given current assets = $3,700,000, Inventory = $1,200,000 and current liabilities = $1,900,000 

Quick ratio = ($3,700,000 - $2,100,000) / $1,900,000 

Quick ratio = $1,600,000 / $1,900,000 

Quick ratio = 0.84210526 

Quick ratio = 0.84 times 

On the other hand, the cash ratio is computed as follows: 

“ Cash ratio = Cash and marketable securities / Short-term liabilities” 

Given Cash and marketable securities = $400,000 and Current liabilities = $1,900,000 

Hence, cash ratio = $400,000 / $1,900,000 

Cash ratio = 4/19 = 0.210526315789 

Cash ratio = 0.21 times 

Problem 5 

Qn. “Book value per share = Stockholder’s equity / Number of outstanding shares” 

Book value per share = $35 million / $10 million 

Book value per share = 3.5 

Qn. Earnings per share = (Dividends paid + Retained earnings increment) / Shares outstanding 

Earnings per share = ($2.2 million + $4.8 million) / 10 million 

Earnings per share = 7/10 = 0.7 per share 

Qn. Market-to-book ratio = Market price / Book value per share 

Market-to-book ratio = 9 /3.5 = 2.57 

Qn. Price-earnings ratio = Market price for every share / Earnings for each share 

Price-earnings ratio = 9 / 0.7 = 12.86 

Problem 6 

Given the following information, 

Average collection period = 32 days 

Days of the year= 365 

Accounts receivable turnover = 365 / 32 = 11.40625 

Accounts receivable turnover = Credit sales / Accounts receivable ending balance 

11.40625 = $56.1 million / Accounts receivable ending balance 

Accounts receivable ending balance = $5,61,00,000 / 11.40625 

Accounts receivable ending balance = $49,18,356 

Problem 7 

Silas 4-Wheeler, Inc. has a ROE of 18 percent, equity multiplier of 2, and a profit margin of 18.75 percent. What is Silas 4-Wheeler's total asset turnover and capital intensity? (Round your answers to 2 decimal places.) 

Solution 

ROE = Asset turnover * Profit margin * equity multiplier 

ROE = 18/100 = 0.18 

Profit margin = 0.1875 

Equity multiplier = 2 

0.18 = Asset turnover * 0.1875 * 2 

0.18 = Asset turnover * 0.375 

Asset turnover = 0.18 / 0.375 

Asset turnover = 0.48 

Capital intensity = Total assets / sales = 1 / 0.48 = 2.0833333333 = 2.08 (to 2 dps) 

Problem 8 

Profitability ratios depict an overall firm’s profitability. The profitability ratios have been provided as the return on equity, on assets, operating profit margin and the gross profit margin as provided. Also, the profitability ratios give a company the capability to have more income generation techniques. The following information has been indicated in the question as 

Net sales = $12.5 million, 

Gross profit = $6.9 million 

EBIT = $5.6 million, 

Net income available = $3.2 million 

Common stock dividends = $1.2 million. 

Total assets = $52.5 million 

Common Equity = $21 million 

Shares outstanding = 2 million 

Qn. Calculate the gross profit margin. 

“ Gross profit margin = Gross profit / Net sales * 100” 

Gross profit margin = $6.9 million / $12.5 million *100 

Gross profit margin = 0.552 * 100 = 55.20% 

Qn. Calculate the operating profit margin. 

“ Operating profit margin = EBIT / Net sales * 100” 

Operating profit margin = $5.6 million / $12.5 million * 100 

Operating profit margin = 0.448 * 100 = 44.80% 

Qn. Calculate the profit margin 

“ Profit margin = Net income available / Net sales * 100” 

Profit margin = $3.2 million / $12.5 million * 100 

Profit margin = 0.256 * 100 = 25.60% 

Qn. Calculate the basic earnings power. 

“ Basic earnings power = EBIT / Total assets * 100” 

Basic earnings power = $5.6 million / $52.5 million * 100 

Basic earnings power = 0.106666667 * 100 = 10.67% 

Qn. Calculate the return on assets. 

“ Return on assets = Net income available / Total assets * 100” 

Return on assets = $3.2 million / $52.5 million * 100 

Return on assets = 0.06095238 * 100 = 6.10% 

Qn. Calculate the return on equity. 

Return on equity = Net income available / Common stockholders’ equity * 100 

Return on equity = $3.2 million /$21 million * 100 

Return on equity = 0.15238095 * 100 = 15.24% 

Qn. Calculate the dividend payout. 

Dividend payout = Common stock dividends / Net income available * 100 

Dividend payout = $1.2 million / $3.2 million * 100 

Dividend payout = 0.375 * 100 

Dividend payout = 37.50% 

Reference  

Davies, T., & Crawford, I. P. (2005). Business accounting and finance. Berkshire: McGraw-Hill Education. 

Hoyle, J. B., Schaefer, T., & Doupnik, T. (2015). Advanced accounting. McGraw Hill. 

https://www.aaii.com/journal/article/16-financial-ratios-for-analyzing-a-companys-strengths-and-weaknesses.touch