Chapter 13, Problem 10P

Leverage relates to how much of someone else’s money a business or individual is using to finance its operations. Discuss leverage and the various debt ratios used by an organization. Discuss the benefits and perils of too much leverage. Choose a debt ratio and discuss the importance of monitoring that ratio. For example, the time's interest earned ratio is an important ratio to monitor because it shows if a firm can pay the interest payments on its debt each month. The benefits of leverage allow a firm to use borrowed funds to generate income. Too much leverage can make it difficult for a company to make those payments each month.

The DuPont equation shows the relationships among asset management, debt management, and  ratios. Management can use the DuPont equation to analyze ways of improving the firm's performance. Its equation is:   Ratio analysis is important to understand and interpret financial statements; however, sound financial analysis involves more than just calculating and interpreting numbers.  factors also need to be considered. Quantitative Problem: Rosnan Industries' 2022 and 2021 balance sheets and income statements are shown below.   Balance Sheets   2022   2021   Assets                   Cash and equivalents   $ 70       $ 55   Accounts receivable     275         300   Inventories     375         350       Total current assets   $ 720       $ 705   Net plant and equipment     2,000         1,490   Total assets   $ 2,720       $ 2,195                         Liabilities and Equity                   Accounts payable   $ 150       $ 85   Accruals     75         50…

You have been asked by your CEO to evaluate, analyse and calculate commonly used ratios relating to a company’s profitability, liquidity, solvency and management efficiency.  Explain how do analysts use ratios to analyse a firm’s leverage? Which ratios convey more important information to a credit analyst those revolving around the levels of indebtedness or those measuring the ability to service debt?  What is the relationship between a firm’s level of indebtedness and risk?  What must happen in order for an increase in leverage to be successful? Discuss and illustrate all your answer.