Question

This is an excerpt from Blue Design’s 2017 annual report:

Millions	2017	2016
Debit	$50,000	$48,000
Equity	$34,000	$32,000

Part A - What is the debt-to-equity ration for 2017 and 2016 based on end of year values for debt and equity?

Part B – The company had operating leases which totaled $3,200 and $4,000 in 2017 and 2016 (respectively). Assume the leasers were capitalized (included in the total amount of debt reported). What is the recalculated debt-to-equity ratio for 2017 and 2016 without the operating leases? What does capitalizing the leases do to risk perception or Blue Design?

Answer 1

Debt equity ratio = total debt / total equity

2016: 48000/32000 = 1.5

2017: 50000/34000 = 1.47

If we assume leases were capitalized and included in debts value,

the recalculated debt equity ratio will be as follows

2016: (48000-4000)/32000 = 1.375

2017: (50000-3200)/34000 = 1.376

A higher debt equity ratio implies that a company is risky.

This is because there is a chance of higher interest payments.

Capitalizing leases have increased the debt equity ratio for Blue Design in both the years.

Thus, doing so leads to a greater risk perception of the company.

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