Question

The Territory Holiday Extravaganza Company Ltd had a bad year in 2016 when it suffered a net loss. Some of the measures of return deteriorated due to the loss. The management of the company are wondering how they can improve their ratios for the following year to keep their jobs and the banks and the shareholders happy. They have come up with the following ideas.

1 Borrow $100 million on long-term debt.
2 Buy back shares for $500 million cash.
3 Expense one-quarter of the goodwill carried on the books.
4 Create a new holiday planning division at a cash cost of $300 million.
5 Purchase a new travel app from “Where do we holiday now?” Ltd, paying $20 million cash.

Requirement
Write a short report to the management showing whether the ideas that they have suggested will cause the current ratio, the debt ratio and the rate of return on ordinary shareholders' equity to either increase, decrease or have no effect, giving your reasons for your decision.

Current ratio = current assets / current liabilities, Debt ratio = total liabilities / total assets Rate of return on ordinary shareholders' equity = net income / ordinary shareholders' equity.

Answer 1

	Current Ratio	Debt Ratio	Rate of return on ordinary shareholders' equity
	current assets / current liabilities	total liabilities / total assets	net income / ordinary shareholders' equity
1	Cash would increase which means the numerator here will increase resulting in INCREASE in current ratio	Debt and cash would increase which means numerator and denoinator both here will increase resulting in only a mathematical impact (INCREASE)	Borrowing will have no direct impact on this ratio. However interest paid will have an impact
2	Cash would decrease which means the numerator here will decrease resulting in DECREASE in current ratio	Cash would decrease which means the denominator here will decrease resulting in INCREASE in this ratio	This ratio would increase because equity will reduce as a result of buyback. The denominator will reduce so there will be INCREASE in this ratio
3	No effect	No effect	Both numerator and denominator will reduce. So there will be a mathematical impact on the ratio which will DECREASE the ratio
4	Cash would decrease which means the numerator here will decrease resulting in DECREASE in current ratio	Cash would decrease but assets would increase by the same amount which means there will be no impact	No effect
5	Cash would decrease which means the numerator here will decrease resulting in DECREASE in current ratio	Cash would decrease but assets would increase by the same amount which means there will be no impact	No effect