Aradya Ltd. had a debt equity ratio of 2.5: 1.

State which of the following transactions will not affect the Debt Equity Ratio?

₹2,00,000 paid to creditors

The correct answer is option 2- ₹2,00,000 paid to creditors.

Debt-equity ratio = 2.5:1= Debt/equity. 
So lets assume Debt is ₹25,00,000 and equity is ₹10,00,000.

1) Purchase of ₹15,00,000 machinery by taking a bank loan of ₹12,00,000 = Due to this transaction debt is increased by ₹12,00,000. So, new debt is ₹37,00,000 and equity is still ₹10,00,000. So debt-equity ratio = 37,00,000/10,00,000 i.e. 3.7:1.

2) ₹2,00,000 paid to creditors = Due to this transaction current asset and current liability is decreased. So there is no effect on debt-equity ratio.

3) Conversion of ₹1,00,000 debentures into Equity shares of ₹100 each = Due to this transaction debt is decreased by ₹1,00,000 and equity is increased by same amount. So new debt is ₹24,00,000 and Equity is ₹11,00,000. So, new debt-equity ratio is 24,00,000/11,00,000 i.e. 24:11.

4) Sale of furniture (book value of ₹5,00,000) for ₹5,50,000 = Due to this transaction current asset is increased and fixed asset is decreased. But fixed asset is sold on profit of ₹50,000, due to which shareholders funds is increased by this amount means equity increased by ₹50,000. So no change in debt but equity is increased by ₹50,000. So, new debt-equity ratio is 25,00,000/10,50,000 means 250:105 or 50: 21.