Financing the Expansion for Optimal Debt Ratio: CFA Level 1 Exam Preparation

Determining the Financing Mix for Altman Company's Expansion

Prev Question Next Question

Question

The Altman Company has a debt ratio of 33.33 percent, and it needs to raise $100,000 to expand. Management feels that an optimal debt ratio would be 16.67 percent. Sales are currently $750,000, and the total assets turnover is 7.5. How should the expansion be financed so as to produce the desired debt ratio?

Answers

A. Finance 20 percent debt, 80 percent equity.

B. Finance 40 percent debt, 60 percent equity.

C. Finance it all with debt.

D. Finance 50 percent debt, 50 percent equity.

E. Finance it all with equity. E

Show Answer

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E.

Explanation

Old debt ratio = 0.3333; New debt ratio = 0.1667.

$750,000/TA= 7.5.

TA = $100,000.

Debt = 0.3333($100,000) = $33,330.

New TA = $100,000 + $100,000 = $200,000.

New Debt = $200,000(0.1667) = $33,340.

Altman's current debt of $33,330 represents approximately 16.67% of total assets following the expansion, thus the firm should finance with 100 percent equity.

Prev Question Next Question