5. More on debt management ratios

The extent of financial leverage in a firm

Debt ratios measure the proportion of total assets financed by a firms creditors.

Sunny Co. has a debt-to-equity ratio of 4.00, compared to the industry average of 3.20. Its competitor Carter Co., however, has a debt-to-equity ratio of 6.00. Based on what debt-to-equity ratios imply, which of the following statements is true?

Carter Co. has higher creditworthiness as compared to Sunny Co.

Carter Co.s creditors face lesser risk than the average financial risk in the industry.

Carter Co. has greater financial risk as compared to Sunny Co. and to the average financial risk in the industry.

Sunny Co.s shareholders expect magnified returns but higher risk as compared to Carter Co.

Suppose the stock price of Sunny Co. falls by 10%. What impact will it have on its market-to-debt ratio if nothing changes in the companys balance sheet?

The market debt ratio will decrease, reflecting a decrease in the financial risk of the company.

The market debt ratio will decrease, reflecting an increase in the financial risk of the company.

The market debt ratio will increase, reflecting an increase in the financial risk of the company.

The market debt ratio will increase, reflecting a decrease in the financial risk of the company.

Data Collected (Millions of dollars)

	Year 1
EBITDA	$300
Interest payments	$30
Principal payments	$24
Lease payments	$14

Sunny Co. reported the following figures in its annual report.

Based on the information, Sunny Co. has the ability to cover its fixed financial charges times.