Assume a company acquires land, using borrowed money. Assume the land earns no income during the year. Which of the following statements is correct regarding the effect of buying the land and borrowing the money?
A) Capital structure leverage will increase.
B) Its interest coverage ratio will increase.
C) Its current ratio will increase.
D) Its return on assets will increase.

Question

Quizplus · Accepted Answer

Buying land using borrowed money increases the company's debt, which in turn increases its leverage. Therefore, capital structure leverage will increase. The interest coverage ratio will decrease as a result of the interest expenses associated with the borrowing. The current ratio will be unaffected since the acquisition of land is not considered current assets or liabilities. Finally, buying the land will not generate any income, so the return on assets will not increase.

Assume a Company Acquires Land, Using Borrowed Money