Question

The following information was drawn from the balance sheets of two companies:

Company	Assets			=	Liabilities			+	Equity
East		207,000				78,000				129,000
West		606,000				158,000				448,000

Required
a. Compute the debt-to-assets ratio to measure the level of financial risk of both companies.
b. Compare the two ratios computed in requirement a to identify which company has the higher level of financial risk.
East 207,000 606,000 78,000 158,000 129,000 448,000 West Required a. Compute the debt-to-assets ratio to measure the level of financial risk of both companies. b. Compare the two ratios computed in requirement a to identify which company has the higher level of financial risk. Complete this question by entering your answers in the tabs below. Required A Required B Compute the debt-to-assets ratio to measure the level of financial risk of both companies. (Round your answers to 1 decimal place.) Company Debt to Assets Ratio % East West % < Required A Required B >

Answer 1

(a) Computation of Debt to Assets ratio -

Debt to assets ratio = Total liablities / Total assets

a b с Total Liabilities Total assets Debt-assets ratio (a/b) East West 78000 158000 207000 606000 37.7% 26.1%

(b) Debt to assets ratio indicates the share of the total assets financed by outside funds. A low ratio of debt to total assets is desirable from the point of the creditors/lenders as there is sufficient margin of safety available to them. But its implication for the shareholders are that the debt is not being exploited to make available to them the benefit of trading on equity. A firm with a very high ratio would expose the creditors to higher risk.

compare these two firms, debt to total assets ratio East Co. has the higher ratio which leads it the higher level of financial risk.

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