Paper Clip Office Supply had $24,000,000 in sales last year. Its total asset turnover was 3.0. Interest expense was $100,000 (5% on its $2,000,000 of debt). The company is financed entirely with debt and common equity. What is Paper Clip's debt ratio?
A) 20%
B) 30%
C) 25%
D) 60%
E) 16%

Question

Quizplus · Accepted Answer

The debt ratio is calculated as debt / (debt + equity). We know that the company is financed entirely with debt and common equity, so the debt ratio is equal to debt / (debt + equity). We also know that the company has $2,000,000 of debt and $24,000,000 in sales. The total asset turnover is calculated as sales / assets, so the company's assets are equal to sales / total asset turnover. Therefore, the company's assets are equal to $24,000,000 / 3.0 = $8,000,000. The company's equity is equal to assets - debt, so the company's equity is equal to $8,000,000 - $2,000,000 = $6,000,000. Therefore, the company's debt ratio is equal to $2,000,000 / ($2,000,000 + $6,000,000) = 25%.

Paper Clip Office Supply Had $24,000,000 in Sales Last Year