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Read the information supplied and answer the questions which follow - Leaving Cert Business - Question 7 - 2022
Question 7
Read the information supplied and answer the questions which follow. The Cleaning Crew The Cleaning Crew, a home and industry cleaning company based in Wexfor... show full transcript
Worked Solution & Example Answer:Read the information supplied and answer the questions which follow - Leaving Cert Business - Question 7 - 2022
Step 1
Explain the term Debt/Equity Ratio.
Answer
The Debt/Equity Ratio is a financial metric that compares a company's total debt to its total equity. This ratio indicates the proportion of capital that is raised through borrowing (debt) versus the capital raised through shareholders' invested funds (equity). A higher ratio suggests that the company relies more on debt financing, which may indicate higher financial risk, while a lower ratio signals a greater reliance on equity financing, suggesting lower financial risk.
Step 2
Calculate the Debt/Equity Ratio for 2021 and 2020. Show your workings.
Answer
To calculate the Debt/Equity Ratio, we use the formula:
For 2021:
- Debt Capital: Long-term Loan = €150,000
- Equity Capital: Issued Share Capital + Retained Earnings = €460,000 + €140,000 = €600,000
For 2020:
- Debt Capital: Long-term Loan = €250,000
- Equity Capital: Issued Share Capital + Retained Earnings = €300,000 + €120,000 = €420,000
Step 3
Comment as to whether the Debt/Equity Ratio has improved or dis-improved?
Answer
The Debt/Equity Ratio for The Cleaning Crew decreased from 0.6 in 2020 to 0.25 in 2021. This indicates an improvement in the company’s financial position, as it shows that the business is less reliant on debt financing and more on equity. A lower ratio suggests a lower risk profile, as the company is less vulnerable to financial distress during periods of economic downturn.
Step 4
Discuss the factors a business should consider when choosing a source of finance.
Answer
When choosing a source of finance, a business should consider several key factors:
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Purpose: The source of finance should match the purpose for which it is intended, such as whether it is for short-term needs (like paying suppliers) or long-term purposes (like purchasing equipment).
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Cost: Assessing the cost associated with different finance options, including interest rates and fees (APR).
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Collateral/Security: The need for collateral can impact financing decisions, as some sources require security against loans.
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Fixed Repayments: Understanding whether the financing will involve fixed repayments, particularly for loans versus equity, where there may be no obligations to repay.
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Accessibility/Availability: The ease of obtaining the finance, including considerations for credit checks and acceptance criteria.
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Tax Implications: Recognizing how different forms of finance might affect tax liabilities. For example, interest on debt may be tax-deductible, while equity dividends are not.