Question

Cornerstone Exercise 9-41 (Algorithmic) Ratio Analysis Red Corporation had $2,199,000 in total liabilities and $3,500,000 in total assets as of December 31, 2020. Of Red's total liabilities, $350,000 is long-term. Required: Calculate Red's debt to assets ratio and its long-term debt to equity ratio. Round your answers to four decimal places. Debt to Total Assets Long-Term Debt to Total Equity

Answer 1

Answer 1)

Calculation of Debt to Total Assets Ratio

Debt to total assets ratio is an indicator of financial leverage of a company. It gives details of what proportion of company’s total assets is financed by the outside liabilities. A higher ratio means a higher financial leverage and vice versa.

Debt to Total Assets ratio = Total Liabilities/ Total Assets

                                              = $ 2,199,000/ $ 3,500,000

                                              = 0.6283 times (approximately)

Therefore Debt to Total Assets ratio is 0.6283 times.

Answer 2)

Debt to total assets ratio is also an indicator of financial leverage of a company. It provides the details of what proportion of a company’s total assets are financed by Long term Debt. The higher the ratio, the greater will be the leverage and risk.

Long Term Debt to Total Equity Ratio = Long Term Debt/ Total Shareholder’s equity

                                                                   = $ 350,000/ $ 1,301,000

                                                                  = 0.2690 times (approximately)

Therefore Long term Debt to Equity ratio is 0.2690 times.

Working Notes:

Shareholders’ Equity = Total Assets – Total outside liabilities

                                        = $ 3,500,000 - $ 2,199,000

                                        = $ 1,301,000

Therefore the value of shareholders’ equity is $ 1,301,000