Question

eBook Show Me How Calculator Print Item Ratio of liabilities to stockholders' equity The following data were taken from Alvarado Company's balance sheet: Dec. 31, 2014 Dec. 31, 20Y3 Total liabilities $4,800,000 $2,240,000 Total stockholders' equity 4,800,000 2,800,000 a. Compute the ratio of liabilities to stockholders' equity for each year. Round your answers to 2 decimal places. Dec. 31, 2014 Dec. 31, 20Y3 b. Has the creditor's risk increased or decreased from December 31, 20Y3, to December 31, 20Y4?

Answer 1

Debt-To-Equity Ratio:

The ratio of liabilities to stockholders' equity is also known as Debt-To-Equity ratios. This ratio reflects the financial leverage of the company in terms of the degree of debt in comparison to the company's own funds. This ratio also reflects the capacity of stockholders' funds to cover the outstanding debt.

Debt to equity ratio = Total Liabilities

Total Stockholders' Equity

Debt to equity ratio for Dec. 31, 20Y3 = $2,240,000    = 0.80

$2,800,000

Debt to equity ratio for Dec. 31, 20Y4 = $4,800,000    = 1.00

$4,800,000

a. Compute the ratio of liabilities to stockholders' equity for each year. Round your answer to 2 decimal places.

Dec. 31 , 20Y4 = 1.00

Dec. 31, 20Y3 = 0.80

b. Has the creditor's risk increased or decreased from December 31, 20Y3, to December 31, 20Y4?

Answer: Creditor's risk has increased. In the year 20Y3, every dollar invested in equity was leveraged by 80 cents of debt. i.e. for every dollar of the company's wholly-owned fund, there was a debt of 80 cents attached. The remaining 20 cents could be taken as a cushion margin. in the year 20Y4, such cushion margin got reduced to nil as for every dollar in equity there was a debt of a dollar attached.