Question

A firm had the following values for the four debt ratios

• Liabilities to Assets Ratio: less than 1.0
• Liabilities to Shareholders' Equity Ratio: greater than 1.0
• Long-Term Debt to Long-Term Capital Ratio: less than 1.0
• Long-Term Debt to Shareholders' Equity Ratio: equal to 1.0

1.Suppose the firm issued short-term debt for cash. Liabilities to Assets

• A. increased
• B. stayed the same
• C. decreased

2.Suppose the firm issued short-term debt for cash. Long-Term Debt to Long-Term Capital

A. increased

• B. stayed the same
• C. decreased

3.Suppose the firm issued long-term debt and used the cash proceeds to redeem short-term debt. Treat as a unified transaction. Liabilities to Shareholders' Equity

A. increased

• B. stayed the same
• C. decreased

4.Suppose the firm issued long-term debt and used the cash proceeds to redeem the short-term debt. Treat as a unified transaction. Long-Term Debt to Shareholders' Equity

A. increased

• B. stayed the same
• C. decreased

5.Suppose the firm redeemed (paid off) long-term debt with cash. Liabilities to Assets

A. increased

• B. stayed the same
• C. decreased

6.Suppose the firm redeemed (paid off) long-term debt with cash. Long-Term Debt to Long-Term Capital

A. increased

• B. stayed the same
• C. decreased

7.Suppose the firm issued short-term debt and used the cash proceeds to repurchase shares of its common stock (treat as a unified transaction). Liabilities to Shareholders' Equity

A. increased

• B. stayed the same
• C. decreased

8.Suppose the firm issued short-term debt and used the cash proceeds to repurchase shares of its common stock (treat as a unified transaction). Long-Term Debt to Shareholders' Equity

• A. increased
• B. stayed the same
• C. decreased

9.Suppose the firm issued $50 million of long-term debt and $50 million of common stock and used the proceeds to buy the building and equipment needed to produce a promising new product. Liabilities to Assets

• A. increased
• B. stayed the same
• C. decreased

10.Suppose the firm issued $50 million of long-term debt and $50 million of common stock and used the proceeds to buy the building and equipment needed to produce a promising new product. Long-Term Debt to Shareholders' Equity

A. increased

• B. stayed the same
• C. decreased

Answer 1

1. B. Stays the Same

The liability to asset ratio shows the percentage of assets that are being funded by debt.

As firm issued Short Term Debts for Cash, Liability of the firm will increase and as Cash comes in, Assets also increase Increased.

Hence, Liabilities to Assets ratio will remains same.

2. B. Stayed the same

As firm issued Short-term debt for cash. It doesn’t belong to Long-term debt or Long-term Capital.

Hence, it doesn’t affect any of the above at all.

Hence, Long-Term Debt to Long-Term Capital Ratio will remains same as it is.

3. C. Stayed the same

As Firm issued long-term debt and used the cash proceeds to redeem short-term debts (As it is unified transaction, we assumed all the proceeds raised from issue of long term debt used to redeem short-term debts), ultimate liabilities of the firm remains the same, just their classification will change.

Long-term or Short-term debts not belong to Shareholders’ Equity.

As Liability of the firm wont change, Liabilities to Shareholders’ Equity will remains same.

4. A. Increased

As firm issued firm issued long-term debt and used the cash proceeds to redeem the short-term debt, firms long-term liabilities will increased.

In this case shareholders Equity will remains the same; but as long-term debt increased, Long-Term Debt to Shareholders' Equity will also increase.