Question of the Week

A company issues some shares in order to finance the purchase of some more production facilities. If previously, the company has a debt-to-equity ratio of 0.7:1, what is likely to happen to this ratio as a result of this transaction?

a) The debt-to-equity ratio will drop.
b) The debt-to-equity ratio will rise.
c) Since debt was not involved, it cannot be determined with the information given, how this ratio will be affected.
d) The debt-to-equity ratio will not be affected.

Answer:

The correct answer is: a)

This transaction will increase the assets of the company and its equity by the same amount. Hence, with a constant debt and an increasing equity, the debt-to-equity ratio should drop.