What does a high debt to equity ratio indicate about a company?

What does a high debt to equity ratio indicate about a company?

• A. The company is less risky
• B. The company relies heavily on borrowed funds
• C. The company has ample liquid assets
• D. The company has strong profitability

Answer: (B)

A high debt to equity ratio signifies that a company relies significantly on borrowed funds to finance its operations and growth. This ratio is calculated by dividing total liabilities by shareholders' equity, and when it is high, it indicates that the company is using more debt than equity to fund its assets. This can suggest that the company is leveraging debt to increase its potential returns, but it also indicates a greater level of financial risk. High levels of debt can mean that the company is more vulnerable to economic downturns or fluctuations in cash flow, which might impact its ability to meet interest payments and repay the principal. In the context of the other options, they would not adequately capture the implications of a high debt to equity ratio. A lower risk profile would typically be associated with a lower debt to equity ratio, implying financial stability with less reliance on debt. Ample liquid assets and strong profitability are not directly indicated by a high debt to equity ratio, as these factors pertain more to a company’s ability to meet its short-term obligations and overall financial health, rather than its financing structure.

A high debt to equity ratio signifies that a company relies significantly on borrowed funds to finance its operations and growth. This ratio is calculated by dividing total liabilities by shareholders' equity, and when it is high, it indicates that the company is using more debt than equity to fund its assets.

This can suggest that the company is leveraging debt to increase its potential returns, but it also indicates a greater level of financial risk. High levels of debt can mean that the company is more vulnerable to economic downturns or fluctuations in cash flow, which might impact its ability to meet interest payments and repay the principal.

In the context of the other options, they would not adequately capture the implications of a high debt to equity ratio. A lower risk profile would typically be associated with a lower debt to equity ratio, implying financial stability with less reliance on debt. Ample liquid assets and strong profitability are not directly indicated by a high debt to equity ratio, as these factors pertain more to a company’s ability to meet its short-term obligations and overall financial health, rather than its financing structure.