(Assessing leverage use) Some financial data for three corporations are displaye

Question

(Assessing leverage use) Some financial data for three corporations are displayed here.

a-      Which firm appears to be excessively leveraged?

b-      Which firm appears to be employing financial leverage to the most appropriate degree?

c-       What explanation can you provide for the higher price/earnings ratio enjoyed by firm B as compared with firm A?

INDUSTRY NORM MEASURE Debt ratio Times interest covered Price/earnings ratio FIRM A 20% 8 times 9 times FIRM B 25% 10 times 11 times FIRM C 10% 7 times 6 times 20% 9 times 10 times

Explanation / Answer

A.Firm c is excessively leveraged as its debtratio is highest and times covered is lowest.

B, Firm b is employing appropriate leverage as its times coveraved is highest.

C.Firm b has high interest coverage ratio and hence higher earnings, so it has higher price earnings than firm a.

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