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Question:

At the beginning of the year, a firm securitizes half of its accounts receivable and uses the proceeds to pay down principal on a long-term bank loan. These transactions will:

A decrease the firm’s debt-to-equity ratio.
Explaination

Securitizing accounts receivable means the firm sells them to a special purpose vehicle that will issue asset-backed securities. This transaction will remove these accounts receivable from the firm’s balance sheet. Using the proceeds to retire long-term debt will decrease liabilities by the same amount. Shareholders’ equity is not affected. Therefore, the debt-to-equity ratio will decrease. The current ratio will decrease because accounts receivable (a current asset) decrease while current liabilities remain unchanged (or decrease only by any current portion of the debt paid down). The interest coverage ratio will increase because paying down long-term debt will decrease interest expense.