Montclair company is considering a project that will require a $500,000 loan. it presently has total liabilities of $220,000, and total assets of $620,000. 1. compute montclair’s (a) present debt-to-equity ratio and (b) the debt-to-equity ratio assuming it borrows $500,000 to fund the project.

choose numerator: / choose denominator:
total liabilities / total equity debt-to-equity ratio
(a) $220,000 / $400,000 0.55
(b) $720,000 / 0

a) 0.55:1

b) 1.8:1

Explanation:

a) Montclair's present debt-to-equity ratio is derived by dividing the total debt by the total equity.

However total equity is not given which can be derived from the balance sheet equation: Total Assets = Equity + Total Liabilities; hence total equity = total assets - liabilities = 620,000 - 220,000 = 400,000

Therefore debt to equity ratio = 220,000/400,000 = 0.55. (This means that debt is only about half of equity)

b) Assuming it then borrows $500,000, debts will increase to $720,000 from $220,000. and the revised debt to equity ratio will be: $720,000/$400,000 = 1.8 ( This means that debt has almost become twice as much as equity)

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