If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

Question

Quizplus · Accepted Answer

The equity multiplier can be calculated as follows: Equity Multiplier = Total Assets/Total Equity. If the equity multiplier is 3.0, then total assets are three times the total equity. Therefore, Total Debt = Total Assets - Total Equity. Let's assume the total equity is 1. Then, total assets are 3 and total debt is 2. So, the debt ratio can be calculated as Total Debt/Total Assets = 2/3, which is equal to 0.667. Hence, the statement is true.

If a Firm Finances with Only Debt and Common Equity