Question

Ideal Debt-Equity ratio is

• A. 1 : 1
• B. 1 : 2
• C. 2 : 3
• D. 1 : 3

Hint:

An ideal Debt-Equity ratio of 1:1 ensures financial balance — neither too risky (debt-heavy) nor too conservative (equity-heavy).

Answer 1

The Correct Option is A

Step 1: Understanding Debt-Equity Ratio.
The Debt-Equity Ratio measures the relationship between the company’s borrowed funds (debt) and its shareholders’ funds (equity).
It helps in evaluating the financial structure and the risk level of a company in terms of its reliance on external versus internal capital.
Step 2: Formula.
\[ \text{Debt-Equity Ratio} = \frac{\text{Long-term Debt}}{\text{Shareholders’ Equity}} \] This ratio reflects the extent to which a company is using borrowed funds to finance its assets relative to the funds invested by the owners.
Step 3: Significance of an ideal ratio.
An ideal Debt-Equity Ratio of 1:1 indicates a balanced capital structure — the company has equal proportions of debt and equity.
It ensures financial stability, moderate risk, and an optimal cost of capital.
If the ratio is higher (e.g., 2:1), it means more dependence on debt, which increases financial risk.
If it is lower (e.g., 0.5:1), it means excessive reliance on equity, which may reduce profitability for shareholders.
Step 4: Analysis of options.
- (1) 1 : 1 — Correct, considered the ideal balance between borrowed and owned funds.
- (2) 1 : 2 — Implies excessive equity; conservative structure.
- (3) 2 : 3 — Not standard; rarely used.
- (4) 1 : 3 — Implies high equity with little debt, not ideal for maximizing return.
Step 5: Conclusion.
Hence, the ideal Debt-Equity Ratio is 1:1.