Question

In: Finance

7. Which of the following company actions will have no effect on its Leverage Ratio? a)...

7. Which of the following company actions will have no effect on its Leverage Ratio?
a) It issues (sells) new equity shares and uses the money to purchase equipment
b) It issues (sells) new equity shares and uses the money to pay off exactly that amount in bank loans
c) It issues (sells) a bond and uses the money to pay off exactly that amount in bank loans
d) It issues (sells) a bond and uses the money to return to owners

Solutions

Expert Solution

Leverage Ratio is the ratio that tells us about the amount of debt and equity in the capital structure of a company. Thus, it will get affected by transactions that result in a change in equity or a change in debt. So, lets evaluate each option on the basis of this concept:

a) New equity share are being issued to buy equipment. This transaction results in increase in equity. So, it will have an effect on leverage ratio. Incorrect choice.

b) New equity share are issued to pay off bank loans. This transaction will result in an increase in equity and a decrease in debt. So, it will definitely affect the leverage ration. Incorrect choice.

c) New bonds are being issued to pay of bank loans of same amount. This transaction will increase and decrease the debt with the same amount. So, on net basis it will have no effect on the level of debt or equity. Thus, it will not have an effect on leverage ratio. So, this is the correct choice.

d) This transaction will increase the debt and decrease the equity. So, it will have an effect on the leverage ratio. Incorrect choice.

jeff jeffy answered 2 years ago
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