Leverage Ratios

Grammatico Company has just completed its third year of operations. The income statement is as follows:

Sales	$ 2,460,000
Less: Cost of goods sold	1,410,000
Gross profit margin	$ 1,050,000
Less: Selling and administrative expenses	710,000
Operating income	$ 340,000
Less: Interest expense	140,000
Income before taxes	$ 200,000
Less: Income taxes	68,000
Net income	$ 132,000

Selected information from the balance sheet is as follows:

Current liabilities	$1,000,000
Long-term liabilities	1,500,000
Total liabilities	$2,500,000
Common stock	$4,000,000
Retained earnings	750,000
Total stockholders' equity	$4,750,000

Required:

Note: Round answers to two decimal places.

1. Compute the times-interest-earned ratio. fill in the blank 1

2. Compute the debt ratio. fill in the blank 2

3. CONCEPTUAL CONNECTION Assume that the lower quartile, median, and upper quartile values for debt and times-interest-earned ratios in Grammaticos industry are as follows:

Time-interest-earned		2.4, 5.4, 16.1
Debt		0.3, 0.8, 2.4

How does Grammatico compare with the industrial norms? Does it have too much debt? The times-interest-earned ratio is very close to the lower quartile, which means that relative to most companies in the industry, Grammatico Company has a

significantno significantsignificant

expense burden (relative to its income). Its debt ratio is in the lower quartile, which means that the company

may stillmay not may still

have additional credit. Because of its interest expense and income level, however, Grammatico should be very careful about taking on additional debt.