CSLB Law & Business ExamBusiness FinancesMedium
A contractor is applying for a business loan and the bank requests a debt-to-equity ratio. The company's balance sheet shows total liabilities of $150,000 and total owner's equity of $100,000. What is the company's debt-to-equity ratio?
- A1.50:1
- B2.50:1
- C0.67:1
- D1.00:1
Show answer & explanationAnswer & explanation
Correct answer: A. 1.50:1
The debt-to-equity ratio is calculated by dividing total liabilities by total owner's equity. In this case, $150,000 (Total Liabilities) / $100,000 (Owner's Equity) = 1.5. This is expressed as 1.5:1.
Why the other options are wrong
- B. Incorrect. This might be a sum of liabilities and equity divided by equity, or another miscalculation.
- C. Incorrect. This would be if equity was divided by liabilities ($100,000 / $150,000).
- D. Incorrect. This would indicate liabilities equal equity, which is not the case here.
Debt-to-Equity Ratio
A financial leverage ratio that indicates the relative proportion of shareholders' equity and debt used to finance a company's assets, reflecting the extent to which owner's equity can cover all outstanding debts.
- Formula: Total Liabilities / Total Owner's Equity.
- Higher ratio implies greater reliance on debt financing.
- Used by lenders to assess risk and by investors to assess financial health.
Memory trick: Solvency is about surviving the long haul, debt vs. equity.