Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which of the following formulas represents the debt-to-capital ratio?

1. Total Debt / (Total Debt + Total Shareholders Equity)

2. Total Assets / Total Liabilities

3. Total Debt / Total Assets

4. Total Equity / Total Debt

The correct answer is: Total Debt / (Total Debt + Total Shareholders Equity)

The debt-to-capital ratio is a financial metric that assesses the extent to which a company is financing its operations through debt versus wholly-owned funds. It provides insight into a company's leverage and financial stability. The debt-to-capital ratio is calculated by taking the total debt and dividing it by the sum of total debt and total shareholders' equity. This formula highlights the proportion of total financing that comes from debt relative to the total capital employed in the business. In this context, the ratio is significant because it helps investors and analysts understand the risk structure of a company. A higher ratio may indicate greater financial risk, as more capital is being sourced from debt, which must be repaid regardless of the company's earnings level. Conversely, a lower ratio suggests a more conservative capital structure with less reliance on borrowed funds. The other options provided do not represent the debt-to-capital ratio. For example, the second option compares total assets to total liabilities, which is more aligned with the solvency ratio, measuring the ability to meet long-term obligations. The third option calculates total debt as a proportion of total assets, providing insight into leverage but not specifically indicating the relationship of debt to total capital. Lastly, the fourth option creates a ratio that inversely relates total equity