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 $100 million in assets with $90 million in debt and $10 million in equity. LotsofEquity, Inc. finances its $100 million in assets with $10 million in debt and $90 million in equity. What are the debt ratio, equity multiplier, and debt-to-equity ratio for the two firms?
A) LotsofDebt: 90 percent, 10 times, 9 times, respectively; and LotsofEquity: 10 percent, 1.11 times, 0.1111 times, respectively
B) LotsofDebt: 10 percent, 1.11 times, 0.1111 times, respectively; and LotsofEquity: 90 percent, 10 times, 9 times, respectively
C) LotsofDebt: 90 percent, 1.11 times, 0.1111 times, respectively; and LotsofEquity: 10 percent, 10 times, 9 times, respectively
D) LotsofDebt: 10 percent, 10 times, 9 times, respectively; and LotsofEquity: 90 percent, 1.11 times, 0.1111 times, respectively

Question

Quizplus · Accepted Answer

The debt ratio is calculated as total debt divided by total assets. For LotsofDebt, Inc., it's $90 million / $100 million = 90%. For LotsofEquity, Inc., it's $10 million / $100 million = 10%. The equity multiplier is total assets divided by total equity. For LotsofDebt, Inc., it's $100 million / $10 million = 10 times. For LotsofEquity, Inc., it's $100 million / $90 million = 1.11 times. The debt-to-equity ratio is total debt divided by total equity. For LotsofDebt, Inc., it's $90 million / $10 million = 9 times. For LotsofEquity, Inc., it's $10 million / $90 million = 0.1111 times.

You Are Considering a Stock Investment in One of Two