Question
What does high debt to equity ratio indicate? (Select the correct answer from those listed below the following statements). (1) High risk in the business (2) High level of borrowing (3) High profitability levels (4) High company valuation (1) and (2) are correct (1) and (3) are correct (3) and (4) are correct None of the above are correct
Answer
4.5
(137 Votes)
Leon
Master · Tutor for 5 years
Answer
(1) and (2) are correct
Explanation
## Step1: Analyse the implication of high debt to equity ratio. The debt-to-equity ratio is a measure that compares a company's total debt liabilities to its shareholder equity and can indicate the level of risk a company poses to creditors or investors. ## Step2:Analyse each proposition based on our understanding of the term. 1) High risk in the business: This is indeed correct, since a high ratio generally means that a company has used more borrowing to finance its operation, which translates to higher risk in case the firm cannot return its loans.2) High level of borrowing: This is unquestionably true. A high ratio manifests that the firm has generated significant part of its capital by borrowing.3) High profitability levels: Incorrect. Even though borrowing can bring additional resources to potentially make more profit, debts genesis routine interest payments which might lower actual profitability.4) High company valuation: Incorrect. High ratio exposes more loans against the equity, unsettling lenders or investors because of the higher risk of default, may decrease company valuation.## Step3:Generate the correct statement by matching our previous judgements to these options. Configuration of statement "1) and 2) are correct" is correct based on the analysed facts.