Broncos Art, Inc. reported the following trend analysis to its bank as an attach

Question

Broncos Art, Inc. reported the following trend analysis to its bank as an attachment to a loan application.

You have been asked to evaluate the long-term borrowing capacity. You know that a rule of thumb for this industry for the debt/ equity ratio is 1 to 1.

Required:

a) Compute the debt/ equity ratio for 2006, 2005, and 2004, using the debt ratio as a guide.

b) Comment on the long-term borrowing ability of this firm.

2006 2005 2004 Fixed Charged Ratio 4 2.5 1.54 Times Interest Earned Ratio 4.94 3.17 2.08 Debt Ratio 0.47 0.51 0.56 Debt to Tangible Net Worth Ratio 0.91 1.06 1.36

Explanation / Answer

a. Debt Ratio = Total Debt / Total Assets

Equity to Total Assets = Equity / Total Assets = 1 - Debt Ratio

Debt Equity Ratio = Debt Ratio / Equity to Total Assets = (Total Debt / Total Assets)x ( Total Assets / Total Equity)

b. As the debt/ equity ratio is gradually decreasing, and is lower than the thumb rule of 1:1 in 2006, the financial flexibility of the firm is increasing. This augurs well for its long-term borrowing ability.

2006 2005 2004 Debt Ratio ( 1) 0.47 0.51 0.56 Equity to Total Assets( 2) 0.53 0.49 0.44 Debt Equity Ratio ( ( 1) / ( 2) ) 0.89: 1 1.04: 1 1.27: 1

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