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.

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 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.

Using leverage reduces a firms potential for gains and losses.

Red Snail Satellite Company has a total asset turnover ratio of 8.50x, 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 Red Snail Satellites debt management ratios?

Ratio	Value
Debt ratio
Times-interest-earned ratio

Influenced by a firms ability to make interest payments and pay back its debt, if all else is equal, creditors would prefer to give loans to companies with debt ratios.