A small manufacturing company has an equity multiplier of 2.5. All of the manufacturing company’s assets are financed by a bank with a combination of long-term debt and equity.
Calculate the company’s debt ratio using this accounting information?
Accounting Answer:
If company has an equity multiplier of 2.5, this means that the company has $2.5 of asset against every dollar of equity that is issued in the form of common stock.
The first step is to calculate the Equity Ratio of the company:
Formula of Equity Ratio is : 1/Equity Multiplier
Equity Ratio = 1 / 2.5 = 0.40 = 40%
Therefore, if the company's assets are 40% financed by common equity, then the remaining 60% of assets are financed by debt, thus debt equity ratio will be 0.60 or 60%. That is the correct answer to the accounting problem.
Wednesday, July 4, 2012
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