Question

AGEC 3423 HW2 Spring 2020 1. True or false? Assets + Liabilities = Owner's Equity. Why? (1 pt) 2. True or false? If the debt/equity ratio increases, the debt/asset ratio will also increase Why? (3pts) 3. True or false? A business with a higher working capital will also have a higher current ratio. Why? (3pts) 4. Use your knowledge of balance sheets and ratio analysis to complete the following abbreviated balance sheet. The current ratio = 2.0, and the debt/equity ratio = 1.0. (12pts) Assets Liabilities Current assets $80,000 Current liabilities Noncurrent assets Noncurrent liabilities Total liabilities Owner equity $100,000 Total assets Total liabilities and owner equity 5. Does a balance sheet show the annual net farm income for a farm business? Why or why not? (3pts)

Answer 1

1. False

Reason : Assets - Liabilities = Owner's Equity as Total assets are always equal to total of liabilities and equity.

2. True

Reason : There can be only 2 ways in which debt/equity ratio increases. We have divided them into 2 cases and proved that debt/assets ratio will also always increase in both the cases :

Case 1 : There is an increase in debt : If additional debt is raised through debentures or loans, there will be a corresponding increase in total assets (Cash/Bank). The debt-equity ratio will increase and, since debt has increased proportionally more than assets, the debt/asset ratio will also increase.

Case 2 : There is a decrease in equity : If there is a decrease in equity through redemption of preference shares or any other scenario, the assets will also decrease as there will be outflow of resources. Hence in such a case Debt will remain the same with a decrease in total assets which will result in an increase in Debt/Assets ratio as well.

3. True

Reason : Working Capital = Current Assets - Current liabilities & Current Ratio = Current Assets/Current liabilities

If Working capital of a company is higher that means Current Assets are more than current liabilities and since in the current ratio as well, current assets comes in the numerator, hence we can conclude that higher the working capital, higher will be the current ratio.

4. Calculation of the missing figures :
Given : i) Current Ratio = 2; ii) Debt/equity = 1
1. Current Liabilities :
Current Ratio = Current Assets / Current Liabilities = 2
80,000 $/ CL = 2
CL = 40,000 $
2. Noncurrent liabilities
Debt/equity Ratio = Debt/Equity = 1
Debt/100,000 $ = 1
Debt = 100,000 $
Debt = Current Liabilities + Noncurrent liabilities
100,000 $ = 40,000 $ + NCL
NCL = 60,000 $
3. Total Liabiltiies
Total Liabilities = CL + NCL
TL = 40,000 $ + 60,000 $
TL = 100,000 $
4. Total liabilities and owners' equity
Total liabilities and owners' equity = Total liabilities + Owner's Equity
Total liabilities and owners' equity = 100,000 $ + 100,000 $
Total liabilities and owners' equity = 200,000 $
5. Noncurrent Assets
Total liabilities and owners' equity = Total assets
Total assets = 200,000 $
Total assets = Current Assets + Noncurrent Assets
200,000 $ = 80,000 $ + NCA
NCA = 120,000 $