$4.$ 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 Dottie$$s 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 company with no leverage, or an unleveraged company

A company with leverage, or a leveraged company

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 firm$$s taxable income and tax obligation.

Red Snail Satellite Company has a total asset turnover ratio of $8\mathrm{.}50$x$,$ net annual sales of $$40$ million, and operating expenses of $$18$ million $($including depreciation and amortization$).$ On its balance sheet and income statement, respectively, it reported total debt of $$2\mathrm{.}50$ million on which it pays a $11\%$ interest rate.

To analyze a company$$s financial leverage situation, you need to measure the firm$$s debt management ratios. Based on the preceding information, what are the values for Red Snail Satellite$$s debt management ratios?

Ratio

Value

Debt ratio

Times$-$interest$-$earned ratio $144\mathrm{.}00$x

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