Which statement about the equity multiplier is true?

Which statement about the equity multiplier is true?

• A. The equity multiplier equals Total Assets divided by Total Equity.
• B. The equity multiplier equals Total Liabilities divided by Total Equity.
• C. The equity multiplier equals Net Income divided by Total Equity.
• D. The equity multiplier equals Total Assets divided by Total Liabilities.

Answer: (A)

The equity multiplier measures how heavily a company is financed with assets relative to shareholders’ equity, i.e., its financial leverage. It is calculated as Total Assets divided by Total Equity. Since Total Assets = Total Liabilities + Total Equity, this ratio also equals 1 plus Total Liabilities divided by Total Equity, illustrating how debt boosts the level of assets funded beyond what equity alone would cover. So, Total Assets divided by Total Equity is the correct description of the equity multiplier. The other expressions mix up what the multiplier represents: Liabilities divided by Equity is a pure leverage ratio but not the equity multiplier; Net Income divided by Equity is a profitability measure; Total Assets divided by Total Liabilities is a different, less direct solvency/coverage ratio. In practical terms, this multiplier appears in the DuPont decomposition of ROE, whereROE = Profit Margin × Asset Turnover × Equity Multiplier. For example, if assets are 200,000 and equity is 100,000, the equity multiplier is 2, meaning assets are funded by twice as much in assets per unit of equity.

The equity multiplier measures how heavily a company is financed with assets relative to shareholders’ equity, i.e., its financial leverage. It is calculated as Total Assets divided by Total Equity. Since Total Assets = Total Liabilities + Total Equity, this ratio also equals 1 plus Total Liabilities divided by Total Equity, illustrating how debt boosts the level of assets funded beyond what equity alone would cover.

So, Total Assets divided by Total Equity is the correct description of the equity multiplier. The other expressions mix up what the multiplier represents: Liabilities divided by Equity is a pure leverage ratio but not the equity multiplier; Net Income divided by Equity is a profitability measure; Total Assets divided by Total Liabilities is a different, less direct solvency/coverage ratio.

In practical terms, this multiplier appears in the DuPont decomposition of ROE, whereROE = Profit Margin × Asset Turnover × Equity Multiplier. For example, if assets are 200,000 and equity is 100,000, the equity multiplier is 2, meaning assets are funded by twice as much in assets per unit of equity.