Question

Assertion (A): If Proprietary Ratio is 0.6 : 1 and Debt-Equity Ratio is 2 : 1, conversion of debentures into Preference Shares will increase the Proprietary as well as Debt-Equity Ratio.

Reason (R): Proprietary Ratio will increase because there is increase in Shareholder’s Funds but Debt-Equity Ratio will decrease because the Long-term Debts are decreased and Shareholder’s Funds (equity) are increased by the same amount.

In the context of the above two statements, which of the following is correct?

Options

• Both (A) and (R) are correct and (R) is the correct reason of (A).

• Both (A) and (R) are correct but (R) is not the correct reason of (A).

• Only (R) is correct.

• Both (A) and (R) are wrong.

Answer 1

Only (R) is correct.

Explanation:

When debentures are converted into preference shares, long-term debt decreases, and shareholder funds increase. As a result, as the proprietor’s funds increase, so does the Proprietary Ratio. However, the debt-equity ratio falls as debt drops and equity rises. Therefore, Reason is correct.