Which of the following best describes how the debt to equity ratio is calculated?

• A. Total shareholders' equity divided by total liabilities
• B. Total liabilities divided by common stock
• C. Total assets divided by total liabilities
• D. Total liabilities divided by total shareholders' equity

Answer: (D)

Verified step by step guidance

1. Understand the concept of the debt to equity ratio: It is a financial metric used to evaluate a company's financial leverage by comparing its total liabilities to its total shareholders' equity.
2. Identify the formula for the debt to equity ratio: The formula is \( \text{Debt to Equity Ratio} = \frac{\text{Total Liabilities}}{\text{Total Shareholders' Equity}} \). This formula shows how much debt a company has for every dollar of equity.
3. Clarify the components: Total liabilities include all debts and obligations the company owes, while total shareholders' equity represents the owners' residual interest in the company after liabilities are subtracted from assets.
4. Compare the options provided: Analyze each option to determine which matches the formula. The correct option is 'Total liabilities divided by total shareholders' equity,' as it aligns with the formula.
5. Apply the formula in practice: To calculate the debt to equity ratio, divide the total liabilities by the total shareholders' equity. This ratio helps assess the company's financial stability and risk level.