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.

Aunt Dotties Linen Inc. reported no long-term debt in its most recent balance sheet. A company with no debt on its books is referred to as:

A. A company with leverage, or a leveraged company

B. A company with no leverage, or an unleveraged company

Which of the following is true about the leveraging effect?

A. 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.

B. Using leverage reduces a firms potential for gains and losses.

Purple Panda Products Inc. 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 $2.50 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 Purple Pandas 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 (encourages/discourages) more debt.