Question

Assuming that the Debt-Equity ratio is 2. State giving reasons whether this ratio would increase, decrease or remain unchanged in the following cases (Any Four)

(a) Purchase of fixed assets on a credit of 2 months

(b) Purchase of fixed assets on a long term deferred payment basis.

(c) Issue of New shares for cash

(d) Issued of Bonus shares

(e) Sale of fixed asset at a loss of Rs 3,000 

Answer 1

Cases	Effect	Reason
Purchase of Fixed Assets on Credit of 2 months	No Change	Purchase of Fixed Assets neither affects the equity nor affects the debts. Thus, debt equity ratio will remain the same.
Purchase of Fixed Assets on long term deferred payment basis	Increase	Purchase of Fixed Assets on long term deferred payment basis results in an increase in the debts. Therefore, debt equity ratio will increase.
Issue of New Shares for cash	Decrease	Issue of New Shares for cash results in an increase in the shareholders’ funds. So, debt equity ratio as a result of this will decrease.
Issue of Bonus shares	No change	Issue of Bonus shares neither affects the shareholders’ funds nor affects the debts. Thus, debt equity ratio will remain the same.
Sale of Fixed Assets at a loss of Rs 3,000	Increase	Sale of Fixed Assets at a loss results in decrease in shareholders’ funds by the amount of loss. While on the other hand, it does not affect the debts. Therefore, debt equity ratio will increase.