CH 5 Accounting Leverage Ratios
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- Leverage refers to using borrowed funds to
- generate returns for stockholders.
- lLeverage is desirable because it creates
- returns for shareholders without using any of their money.
- lLeverage increases risk by committing the
- company to future cash obligations.
Average Total Assets/ Average Stockholders’ Equity
- This ratio measures the extent to which a
- company relies on borrowings (liabilities).
Common Equity Leverage
Net Income / Net Income + Interest Expense (1-tax rate)
- This ratio compares the return available to
- the shareholders to returns available to all capital providers.
Debt to Equity Ratio
Average Total Liabilities/Average Shareholders’ Equity
- This ratio compares liabilities to shareholders’ equity and
- is another measure of capital structure leverage.
Long-term Debt Ratio
Long-Term Debt/ Total Assets
This ratio measures the importance of long-term debt as asource of asset financing.
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