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Zoey was asked by the company controller to determine if the company could borrow more money for an expansion project. When she calculated a leverage ratio, she determined that the company already had 1.5 times as much debt as equity.
Do you agree with her assessment that the company should back off with borrowing more funds at this time?

a. Yes, but if the company would increase sales, it could go ahead with borrowing more funds.
b. Not necessarily. She should investigate the debt to equity ratios of other firms in the same industry.
c. Yes, but the firm should pursue equity investment until the ratio equals 1:1.
d. Not necessarily. In poor economic times, it is good financial strategy for a firm to be highly leveraged.

Respuesta :

jepessoa

Answer:

A) Yes, but if the company would increase sales, it could go ahead with borrowing more funds.

Explanation:

There is no such thing as a good (low) or bad (too high) debt to equity ratio, it varies a lot depending on the industry and expected sales growth. E.g. when Goldman Sachs financed the initial expansion of FB ($10 billion), FB´s equity value was not even close to that value.

Usually financial agents consider a good equity ratio to be around 1 to 1.5, but financial agents themselves may have higher ratios than that.

If the new loan will help the company increase its sales, then it will eventually increase net profits which increase equity.

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