If you’re in a business strategy class, you might be taking the Global Business Simulation Strategy Game, or Glo-Bus for short. You will most likely take two quizzes in this course, Glo-Bus Quiz 1 and Glo-Bus Quiz 2. Both quizzes cover the basic concepts of the game, and Quiz 2 in particular can contain very difficult questions. Many of the questions are financially oriented. Here is a sample question that you will most likely receive.
Given the following year-end dates:
Income statement data quarter 1
Sales Proceeds $50,000
Operating profit $14,400
Net Income $9,555
balance sheet data
Total working capital $70,000
Total assets $149,000
Total current liabilities $26,000
LT Debt (drawing against line of credit) $33,000
Total equity $90,000
Other financial data
Dividend payments $2,250
Based on the figures above, what is the composition of the company’s capital structure, debt and equity? (These percentages are one of the components used in determining the company’s creditworthiness, as explained on the help screen for the GSR’s Comparative Financial Performance page.)
Here are the 5 answers.
20% debt and 80% equity or 20:80.
27% debt and 73% equity or 27:73.
35% debt and 65% equity or 35:65.
37% debt and 63% equity, or 37:63.
None of these.
So to answer that question, we need to look at this income statement and determine what debt and equity are.
Total equity shows up at $90,000, so that’s easy.
But the really hard part is deciphering what debt is. Believe it or not, short-term liabilities are not part of “debt.” And that’s a mistake people make.
So debt is simply long-term debt of $33,000. But what then?
To find the correct ratio, the formula for Debt = Debt/(Debt + Equity)[And for note the equity ratio=equity/(debt+equity)]
Or 33,000/(33,000+90,000)=0.268 or which is 27%. The debt ratio is thus 27% and the rest 73% equity.
The correct answer is the second!