Question

Choose Numerator: Choose Denominator: Debt-to-Equity Ratio 1. (a) 1. (b) 2. If Montclair borrows the funds, does its financing structure become more or less risky?

Montclair Company is considering a project that will require a $570,000 loan. It presently has total liabilities of $185,000 and total assets of $655,000. 1. Compute Montclair’s (a) current debt-to-equity ratio and (b) the debt-to-equity ratio assuming it borrows $570,000 to fund the project. 2. If Montclair borrows the funds, does its financing structure become more or less risky?

Answer 1

Ans. 1 a	Debt to equity ratio   =   Total liabilities / Total stockholder's equity
	$185,000 / $470,000
	0.39 : 1
	*Total stockholder's equity = Total assets - Total liabilities
	$655,000 - $185,000
	$470,000
Ans. 1 b	Loan taken will increase total liabilities and cash by $570,000.
	So, total new liabilities ($185,000 + $570,000)   =		$755,000
	So, total new assets ($655,000 + $570,000) = $1,225,000
	*Total stockholder's equity = Total assets - Total liabilities
	$1,225,000 - $755,000
	$470,000
	Debt to equity ratio   =   Total liabilities / Total stockholder's equity
	$755,000 / $470,000
	1.61 : 1
Ans. 2	If company borrows the loan the new debt to equity ratio will increase which means that the company
	is using more debts for financing than required in the comparison of total stockholder's equity. The higher debt
	to equity ratio is more risky for the company.