46 :- When Debt to Equity Ratio is 2, state, giving reason, whether this ratio will increase, decrease or will have no change in each of the following cases :
(a) Sale of Land (Book Value Rs 4,00,000) for Rs 5,00,000.
(b) Issue of Equity Shares for the purchase of Plant and Machinery worth Rs 10,00,000.
(c) Issue of Preference Shares for redemption of 13% Debentures, worth Rs 10,00,000.
Solution :-
Debt – Equity Ratio is 2 : 1
Let Debt be Rs 20,00,000
And Equity be Rs 10,00,000
(a) Sale of Land (Book Value Rs 4,00,000) for Rs 5,00,000.
Debt – Equity Ratio = Debt/Equity
= 20,00,000/11,00,000
= 1.81 : 1 (Decrease)
Sale of Land (Book Value Rs 4,00,000) for Rs 5,00,000 will decrease the Debt -Equity Ratio as it increase the Shareholder’s Funds by Rs 1,00,000 as profit on sale of land and Debt remanins the same.
(b) Issue of Equity Share for the purchase of Plant and Machinery worth Rs 10,00,000.
Debt – Equity Ratio = Debt/Equity
= 20,00,000/20,00,000
= 1 : 1 (Decrease)
Issue of Equity Shares for the purchase of Plant and Machinery worth Rs 10,00,000 will decrease the Debt – Equity Ratio as it will increase the amount of Shareholder’s Funds by Rs 10,00,000 in the form of Equity Shares and no effect on Long – term Borrowings.
(c) Issue of Preference Shares for redemption of 13% Debentures, worth Rs 10,00,000.
Debt – Equity Ratio = Debt/Equity
= 20,00,000 – 10,00,000/10,00,000 + 10,00,000
= 10,00,000/20,00,000
= 0.5 : 1 (Decrease)
This transaction will decrease the Debt – Equity Ratio as it will decrease the debt by Rs 10,00,000 in the form of redemption of Debenture and Increase the Shareholder’s Funds by the Same amount in the form of Preference Shares.