Montclair Company's current debt-to-equity ratio can be calculated by dividing total liabilities ($160,000) by total equity. Since Total Equity = Total Assets - Total Liabilities, we can find Total Equity by subtracting Total Liabilities from Total Assets. Thus, Total Equity = $680,000 - $160,000 = $520,000.
1. To compute the current debt-to-equity ratio:
a) Debt-to-Equity Ratio = Total Liabilities / Total Equity
b) Substituting the values:
Debt-to-Equity Ratio = $160,000 / $520,000 ≈ 0.31 or 31%
2. If Montclair borrows $620,000 for the project, the new debt-to-equity ratio can be calculated by adding the loan amount to the total liabilities and recalculating the ratio.
a) New Total Liabilities = $160,000 + $620,000 = $780,000
b) New Total Equity = $680,000 (no change)
c) New Debt-to-Equity Ratio = $780,000 / $520,000 ≈ 1.50 or 150%
Therefore, if Montclair borrows the funds, its financing structure becomes riskier as the debt-to-equity ratio increases significantly from 31% to 150%. This indicates a higher proportion of debt to equity in the company's capital structure, which implies increased financial risk.
