Question

8-6. Using The Greasy Spoon Diner balance sheet in Exhibits 8-7 and 8-8, answer the following:

a. What are the debt-to-equity ratios at the beginning and end of th 2014 fiscal (business) year? Has it improved? If so, by how much?

b. The restaurant has less cash at the end of the year than it ad at the beginning. Is this a bad thing or not? Explain.

c. Does the restaurant have enough cash to pay its expenses OnE into 2015? Why or why not?

d. If the restaurant grew its owner's cquity by 31 percent during the 2014 fiscal year, at that rate, how much will the business have n owner's equity after one more vear (on December 31, 2015)?

e. The restaurant added some capital equipment during the year. Did it take out another loan for that equipment, or did it pay cash? Explain your thinking.

Answer 1

a.         Debt-to-equity ratio at beginning of 2006: $9,000/$13,000 = 0.69

Debt-to-equity ratio at end of 2006: $5,000/$17,000 = 0.29

b.         The restaurant doesn’t have any more total assets than it had at the beginning of the year, and it has less cash. On the other hand, the business has less debt than it did. The balance sheet equation (Assets = Liabilities + OE), indicates that the owners have increased equity in the business by paying off (paying down) some debt. Paying down debt is one of the smartest things a business can do with extra cash.

c.         Yes, it has strengthened its cash position by reducing debt, as it won’t have as many payments to make during the year.

d.         $17,000 x 0.31 = $5,270

$17,000 + $5,270 = $22,270

$22,270 x 0.31 = $6,904

$22,270 + $6,904 = $29,174

e.         It must have used cash, because owner’s equity increased. If it had used a loan, that would have had a negative impact on OE.