Question

A firm’s balance sheets for the last two years are as follows: Year 2019 Assets                             &

A firm’s balance sheets for the last two years are as follows:

Year 2019

Assets                                                            Liabilities and Equity

Cash                              $ 9,000                   Accounts payable     $12,000

Market securities         10,000                    Accruals                       10,000

Accounts receivable    21,000                    Current bank note     10,000

Inventory                       20,000                    Long-term debt          30,000

Plant                               40,000                   Common stock            14,000

                                                                        Retained earnings      24,000

                                     $100,000                                                    $100,000

Year 2020

Assets                                                          Liabilities and Equity

Cash                             $12,000                   Accounts payable      $12,000

Market securities         18,000                   Accruals                         10,000

Accounts receivable    18,000                   Current bank note       30,000

Inventory                       10,000                   Long-term debt            10,000

Plant                               42,000                  Common stock               18,000

                                                                        Retained earnings        20,000

                                     $100,000                                                       $100,000

Sales in 2019 were $500,000.    Sales in 2020 were $500,000.

Has the firm’s risk exposure increased?

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Homework Answers

Answer #1

To measure firm's risk exposure , we will calculate Debt equity ratio(D/E Ratio). Higher the debt equity ratio, higher the firm has risk exposure.

D/E ratio = Debt / Equity

In year 2019

Long term debt - 30,000

Equity = Common Stock + Retained earnings = 14000+24000 = 38000

D/E Ratio = 30000/38000

D/E Ratio = 0.79

In year 2020

Long term debt - 10,000

Equity = Common Stock + Retained earnings = 18000+20000 = 38000

D/E Ratio = 10000/38000

D/E Ratio = 0.26

The firm's D/E ratio has substantially reduced from 0.79 to 0.26 in year 2020. Therfore the firm has reduced its risk exposure.

Answer is no. The firm's risk exposure has not increased. It has been reduced in Year 2020

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