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4. Debt (or leverage) management ratios Companies have the opportunity to use varying amounts of different sources of financing, including internal and external sources, to

4. 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.

Company A uses long-term debt to finance its assets, and company B uses capital generated from shareholders to finance its assets. Which company would be considered a financially leveraged firm?

Company B

Company A

Which of the following is true about the leveraging effect?

Interest on debt can be deducted from pre-tax income, resulting in a greater taxable income and a smaller available operating income.

Interest on debt is a tax-deductible expense, which means that it can reduce a firms taxable income and tax obligation.

Red Snail Satellite Company has a total asset turnover ratio of 6.00x, net annual sales of $25 million, and operating expenses of $11 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 7% interest rate.

To analyze a companys financial leverage situation, you need to measure the firms debt management ratios. Based on the preceding information, what are the values for Red Snail Satellites debt management ratios?

Ratio

Value

Debt ratio
Times-interest-earned ratio

The US tax structure influences a firms willingness to finance with debt. The tax structure more debt.

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