Question

The Debt Equity Ratio of a company is 2 : 1. State which of the following would improve, reduce or not change the ratio:

1. Issue of Equity Shares for the purchase of Plant and Machinery worth ₹ 4,00,000.
2. Sale of Furniture (Book value ₹ 4,00,000) for ₹ 3,50,000.

Answer 1

1. The debt-equity ratio will decrease. This is because the issue of equity shares increases the company’s equity, while the purchase of plant and machinery has no effect on the debt. As equity increases and debt remains constant, the debt-equity ratio decreases.
2. The debt-equity ratio will increase. The transaction results in a ₹ 50,000 loss, reducing the company’s equity base. Since the debt remains constant, the drop in equity results in a higher debt-equity ratio.