Problem 3-6 Debt Management Ratios (LG3-3) You are considering a stock investmen

Question

Problem 3-6 Debt Management Ratios (LG3-3) You are considering a stock investment in one of two firms (LotsofDebt, Inc. and LotsofEquity, Inc.), both of which operate in the same industry. LotsofDebt, Inc. finances its $36.50 million in assets with $33.25 million in debt and $3.25 million in equity. LotsofEquity, Inc. finances its $36.50 million in assets with $3.25 million in debt and $33.25 million in equity Calculate the debt ratio. (Round your answers to 2 decimal places.) Debt ratio Lots of Debt Lots of Equity Calculate the equity multiplier. (Round your answers to 2 decimal places.) Equity multiplier Lots of Debt times Lots of Equity times the debt-to-equity. (Round your answers to 2 decimal places.) Debt-to-e Lots of Debt mes Lots of Equity

Explanation / Answer

Part 1)

The debt ratio can be calculated with the use of following formula:

Debt Ratio = Total Debt/Total Assets*100

_____

Using the values provided in the question, we get,

Debt Ratio (Lots of Debt) = 33.25/36.50*100 = 91.10%

Debt Ratio (Lots of Equity) = 3.25/36.50*100 = 8.90%

_____

Part 2)

The equity multiplier is determined as below:

Equity Multiplier = Total Assets/Total Equity

Using the values provided in the question in the above formula, we get,

Equity Multiplier (Lots of Debt) = 36.50/3.25 = 11.23 times

Equity Multiplier (Lots of Equity) = 36.50/33.25 = 1.10 times

_____

Part 3)

The debt-equity ratio is calculated with the use of formula given below:

Debt-Equity Ratio = Total Debt/Total Equity

Using the values provided in the question in the above formula, we get,

Debt-Equity Ratio (Lots of Debt) = 33.25/3.25 = 10.23 times

Debt Equity Ratio (Lots of Equity) = 3.25/33.25 = .10 times

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