Question

The debt equity ratio of M Ltd. is 2:1. State with reasons whether the following transaction will increase, decrease or not change the debt equity ratio :

1. Obtained a loan from ICICI Bank ₹1,00,000 payable after 5 years.
2. Purchased machinery for cash ₹1,50,000.
3. Redeemed 9% debentures ₹1,00,000.
4. Issued equity shares for purchase of machinery of ₹5,00,000 to the vendors.

Answer 1

Debt Equity Ratio = 2 : 1

Debt Equity Ratio =`"Debt"/"Equity" = (20,00,000)/(10,00,000)`[assumed figures]

1. Loan from ICICI - ₹1,00,000
   Increases as debts will increases `(21,00,000)/(10,00,000)= 2.1 :1`
2. Machinery purchased for cash ₹1,50,000
   No change as, machinery is a fixed assets and cash is a current asset, then it will not change debt equity ratio.
3. Redeem 9% debentures of ₹1,00,000
   Debt =20,00,000 - 1,00,000 = ₹19,00,000
   New Ratio =`(19,00,000)/(10,00,000) = 19 :1`
   Thus, Ratio will decrease.
4. Issue equity shares ₹5,00,000 for machinery
   Equity = 10,00,000 + 5,00,000 = 15,00,000
   New ratio =`(20,00,000)/(15,00,000)= 0.8 :1`

Equity will increase, therefore ratio will decrease.