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Assuming That the Debt-to-Equity Ratio is 2 : 1, state giving reasons, which of the following transactions would (i) increase; (ii) Decrease; (iii) Not alter Debt to Equity Ratio: (i) Issue of new shares for cash. (ii) Conversion of debentures into equity shares (iii) Sale of a fixed asset at profit. (iv) Purchase of a fixed asset on long-term deferred payment basis. (v) Payment to creditors.

SOLUTION

Let’s take Debt and Equity as Rs. 2,00,000 and Rs. 1,00,000
Debt to Equity Ratio = Debt Equity
= 2,00,000 / 1,00,000 = 2: 1

(i) Issue of new shares for cash (say Rs. 50,000)
Debt to Equity Ratio = 2,00,000 / 1,00,000 + 50,000
= 1.33: 1 (Decrease)

(ii) Conversion of debentures into equity shares (say Rs. 50,000)
 Debt to Equity Ratio = 2,00,000 / 1,00,000 + 50,000
= 1.33: 1 (Decrease)

(iii) Sale of a fixed asset at profit (say Rs. 50,000 profit)
Debt to Equity Ratio = 2,00,000 / 1,00,000 + 50,000
= 1.33: 1 (Decrease)

(iv) Purchase of fixed asset on long term payment basis (say Rs. 50,000)
Debt to Equity Ratio = 2,00,000 + 50,000 / 1,00,000
= 2.5: 1 (Increase)

(v) Payment to creditors (say Rs. 50,000)
Debt to Equity Ratio = 2,00,000 / 1,00,000
= 2: 1 (No Change)

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