Question

You are considering a stock investment in one of two firms (LotsofDebt, Inc. and LotsofEquity, Inc.), both of which operate in the same industry. LotsofDebt, Inc. finances its $35.25 million in assets with $32.75 million in debt and $2.50 million in equity. LotsofEquity, Inc. finances its $35.25 million in assets with $2.50 million in debt and $32.75 million in equity.

Calculate the debt ratio. (Round your answers to 2 decimal places.)
Debt ratio
Lots of Debt ______%
Lots of Equity ______%
Calculate the equity multiplier. (Round your answers to 2 decimal places.)
Equity multiplier
Lots of Debt _____times
Lots of Equity _____times
Calculate the debt-to-equity. (Round your answers to 2 decimal places.)
Debt-to-equity
Lots of Debt _____times
Lots of Equity _____times

Answer 1

LotsofDebt, Inc. has a high debt ratio, equity multiplier, and debt-to-equity ratio, indicating it is highly leveraged. LotsofEquity, Inc. has a lower debt ratio, equity multiplier, and debt-to-equity ratio, indicating it is primarily financed through equity rather than debt.

Step-by-step explanation:

The debt ratio is calculated by dividing a firm's total debt by its total assets. For LotsofDebt, Inc., the debt ratio is 92.91% (calculated as $32.75 million ÷ $35.25 million). For LotsofEquity, Inc., the debt ratio is 7.09% (calculated as $2.5 million ÷ $35.25 million).

The equity multiplier is calculated by dividing a firm's total assets by its total shareholders' equity. For LotsofDebt, Inc., the equity multiplier is 14.10 times (calculated as $35.25 million ÷ $2.5 million). For LotsofEquity, Inc., the equity multiplier is 1.08 times (calculated as $35.25 million ÷ $32.75 million).

The debt-to-equity ratio is calculated by dividing a firm's total debt by its total equity. For LotsofDebt, Inc., the debt-to-equity ratio is 13.10 times (calculated as $32.75 million ÷ $2.5 million). For LotsofEquity, Inc., the debt-to-equity ratio is 0.08 times (calculated as $2.5 million ÷ $32.75 million).