Question

Debt (or leverage) management ratios

Companies have the opportunity to use varying amounts of different sources of financing, including internal and external sources, to acquire their assets, debt (borrowed) funds, and equity funds.

Which of the following is considered a financially leveraged firm?

A company that uses only equity to finance its assets

A company that uses debt to finance some of its assets

Which of the following is true about the leveraging effect?

Using leverage reduces a firm’s potential for gains and losses.

Using leverage can generate shareholder wealth, but if a company fails to make the interest and principal payments on its debt, credit default can reduce shareholder wealth.

Purple Panda Products Inc. has a total asset turnover ratio of 3.50x, net annual sales of $40 million, and operating expenses of $18 million (including depreciation and amortization). On its balance sheet and income statement, respectively, it reported total debt of $1.75 million on which it pays a 11% interest rate.

To analyze a company’s financial leverage situation, you need to measure the firm’s debt management ratios. Based on the preceding information, what are the values for Purple Panda’s debt management ratios?

Ratio	Value
Debt ratio
Times-interest-earned ratio

The US tax structure influences a firm’s willingness to finance with debt. The tax structure     more debt.

Answer 1

A financially leveraged firm is:

A company that uses debt to finance some of its assets

True/False:

Using leverage reduces a firm’s potential for gains and losses - False

Using leverage can generate shareholder wealth, but if a company fails to make the interest and principal payments on its debt, credit default can reduce shareholder wealth. - True