CFA Practice Question

CFA Practice Question

A firm has a high debt-to-asset ratio. In an inflationary environment, in order to improve this ratio in earlier years, it will prefer:
A. LIFO inventory valuation and accelerated depreciation.
B. LIFO inventory valuation and straight-line depreciation.
C. FIFO inventory valuation and straight-line depreciation.
Explanation: To improve the ratio, it uses FIFO and straight-line depreciation to increase income and hence, retained earnings. FIFO also increases current and total assets in inflationary conditions, improving the debt-to-asset ratio.

User Contributed Comments 6

User Comment
jayjunk Looking at the left side of the B/S, FIFO valuation means the remaining inventory is valued higher, hence larger total assets -> lower debt-to-asset ratio.
dealsoutlook so "improving" debt to asset ratio means reducing the ratio?
Kuki dealsoutlook,
the firm has a large amount of debt relative to the value of the company. therefore to improve this ratio one would either have to
a) decrease the debt OR
b) increase the assets
this means they would have to reduce the ratio

hope this helps...
jpducros subtility often tested in mock exams....don't fall into..
powers023 During inflationary periods, wouldn't LIFO result in higher inventory balances? Which would increase assets and decrease debt to equity ratios? There's a payoff between COGS and value of your inventory so it seems like it could go either way depending on revenue and balance sheet items.
powers023 Disregard last comment, mixed up LIFO and FIFO for a second.
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