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# Finance Questions: Debt/Equity Ratio

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1) What are the debt/equity ratio and the debt ratio for a firm with total debt of \$700,000 and equity of \$300,000?

2) A firm with sales of \$500,00 has average inventory of \$200,000. The industry average for inventory turnover is four times a year. What would be the reduction in inventory if this firm were to achieve a turnover comparable to the industry average?

3) Company A has three debt issues of \$3,000 each. The interest rate on issue A is 4 %, on B the rate is 6%, and on C the rate is 8 %. Issue B is subordinate to A, and issue C is subordinate to both A and B. The firm's operation income EBIT is \$500. Compute the times-interest-earned ratio for issue C. What does the answer imply? Does the answer mean that the interest will not be paid?

4) If a firm has sales of \$42, 791,000 a year, and the average collection period for the industry is 40 days, what should this firm's accounts receivable be if the firm is comparable to the industry?

5) Two firms have sales of \$1 million each, Other financial information is as follows

Firm A Firm B
EBIT \$150,000 \$150,000
Interest expense 20,000 75,000
Income tax 50,000 30,000
Equity 300,000 100,000

What are the operating profit margins and the net profit margins for these two firms? What is their return on equity? Why are hey different? If total assets are the same for each firm, what can you conclude about their respective uses of debt financing?

#### Solution Preview

1)What are the debt/equity ratio and the debt ratio for a firm with total debt of \$700,000 and equity of \$300,000?
Debt Equity Ratio = amount of debt / Amount of equity = 700000/300000=2.33
Debt Ratio = Amount of Debt / (Amount of debt + Amount of equity) = 700000/(700000+300000)=0.70

2)A firm with sales of \$500,00 has average inventory of \$200,000. The industry average for inventory turnover is four times a year. What would be the reduction in inventory if this firm were to achieve a turnover comparable to the industry average?
Required inventory for an inventory turnover of 4 = Sales / Inventory turnover ratio =500000/4=125000
Reduction in inventory = 200000-125000=75000

3)Company A has three debt issues of \$3,000 each. The interest rate on issue A is 4 %, on B the rate is 6%, and on C the rate is 8 %. Issue B is subordinate to A, and issue C is subordinate to both A and B. The firm's operation income EBIT is ...

#### Solution Summary

This solution solves five finance questions, addressing debt ratio, inventory turnover, times-interest-earned ratio and operating profit margins.

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