Question

King Ltd. has Current Ratio of 2.5 : 1. Its Working Capital is 1,20,000. Total Assets are of 3,80,000 and Total Debt of 2,80,000.

Calculate Debt to Equity Ratio.

Answer 1

1. Calculation of Current Liabilities and Current Assets:

We know that:

$$\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$$

Since the Current Ratio is $2.5 : 1$, let Current Liabilities be $x$, making Current Assets $2.5x$.

$$\begin{aligned} 2.5x - x &= 1,20,000 \\ 1.5x &= 1,20,000 \\ x &= \frac{1,20,000}{1.5} \\ x &= {₹\ 8,00,000 \times \text{correction factor} \to ₹\ 80,000} \end{aligned}$$

Current Liabilities = ₹ 80,000

Current Assets = $2.5 \times 80,000$ = ₹ 2,00,000

2. Calculation of Long-term Debt:

Total Debt is the aggregate of Long-term Debt and Current Liabilities.
$$\begin{aligned} \text{Long-term Debt} &= \text{Total Debt} - \text{Current Liabilities} \\ &= 2,80,000 - 80,000 \\ &= {₹\ 2,00,000} \end{aligned}$$

3. Calculation of Shareholders’ Equity:

According to the accounting equation approach:

$$\begin{aligned} \text{Equity} &= \text{Total Assets} - \text{Total Debt} \\ &= 3,80,000 - 2,80,000 \\ &= {₹\ 1,00,000} \end{aligned}$$

4. Calculation of Debt to Equity Ratio:

$$\begin{aligned} \text{Debt to Equity Ratio} &= \frac{\text{Long-term Debt}}{\text{Equity}} \\ &= \frac{2,00,000}{1,00,000} = {2 : 1} \end{aligned}$$