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Question

Assuming That the Debt to Equity Ratio is 2 : 1, state giving reasons, which of the following transactions would (i) increase; (ii) Decrease; (iii) Not alter Debt to Equity Ratio:

(i) Issue of new shares for cash.

(ii) Conversion of debentures into equity shares

(iii) Sale of a fixed asset at profit.

(iv) Purchase of a fixed asset on long-term deferred payment basis.

(v) Payment to creditors.

(i) Issue of new shares for cash.

(ii) Conversion of debentures into equity shares

(iii) Sale of a fixed asset at profit.

(iv) Purchase of a fixed asset on long-term deferred payment basis.

(v) Payment to creditors.

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Solution

Let’s take Debt and Equity as Rs 2,00,000 and Rs 1,00,000

$\begin{array}{l}\mathrm{Debt}\mathrm{}\mathrm{to}\mathrm{}\mathrm{Equity}\mathrm{}\mathrm{Ratio}=\frac{\mathrm{Debt}}{\mathrm{Equity}}\\ \text{=}\frac{2,00,000}{1,00,000}=2:1\end{array}$

(i) Issue of new shares for cash (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000+50,000}=1.33:\text{1(Decrease})$

(ii) Conversion of debentures into equity shares (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000+50,000}=1.33:\text{1(Decrease})$

(iii) Sale of a fixed asset at profit (say Rs 50,000 profit)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000+50,000}=1.33:\text{1(Decrease})$

(iv) Purchase of fixed asset on long term payment basis (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000+50,000}{1,00,000}=2.5:\text{1(Increase})$

(v) Payment to creditors (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000}=2:1(\text{No Change)}$

$\begin{array}{l}\mathrm{Debt}\mathrm{}\mathrm{to}\mathrm{}\mathrm{Equity}\mathrm{}\mathrm{Ratio}=\frac{\mathrm{Debt}}{\mathrm{Equity}}\\ \text{=}\frac{2,00,000}{1,00,000}=2:1\end{array}$

(i) Issue of new shares for cash (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000+50,000}=1.33:\text{1(Decrease})$

(ii) Conversion of debentures into equity shares (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000+50,000}=1.33:\text{1(Decrease})$

(iii) Sale of a fixed asset at profit (say Rs 50,000 profit)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000+50,000}=1.33:\text{1(Decrease})$

(iv) Purchase of fixed asset on long term payment basis (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000+50,000}{1,00,000}=2.5:\text{1(Increase})$

(v) Payment to creditors (say Rs 50,000)

$\text{Debt to Equity Ratio =}\frac{2,00,000}{1,00,000}=2:1(\text{No Change)}$

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