Question

The Debt-Equity Ratio of a Company is 1.8 : 1. Which of the following would increase, decrease or not change it?

1. Purchase of Motor Vehicle for ₹ 20 Lac of which 60% payment is to be made immediately and remaining 40% after 18 months.
2. Sale of Machinery costing ₹ 5,00,000 for ₹ 4,00,000.
3. Tax refund of ₹ 40,000 during the year.
4. Redemption of 6% Debentures.
5. Dividend proposed by directors of the Company.
6. Dividend declared by shareholders of the Company.

Answer 1

Tr. No.	Effect on Debt Equity Ratio	Reason
1.	Increase	Since 40% of the ₹ 20 lakh payment is due after 18 months, it increases long-term debt without affecting equity, leading to an increase in the Debt-Equity Ratio.
2.	Increase	The ₹ 1 lakh loss reduces retained earnings (equity) while debt remains unchanged, so the Debt-Equity Ratio increases.
3.	Decrease	The ₹ 40,000 refund increases profit and thus equity, while debt stays the same, causing the Debt-Equity Ratio to decrease.
4.	Not change	Both debt and equity decrease by the same amount, there is no net effect on the Debt-Equity Ratio. Therefore, the Debt-Equity Ratio remains unchanged.
5.	Not change	A proposed dividend is not a liability until declared, so it has no effect on either debt or equity, and the Debt-Equity Ratio remains unchanged.
6.	Increase	Once declared, the dividend reduces equity (reserves), with no impact on debt, leading to an increase in the Debt-Equity Ratio.