Some financial data for three corporations are displayed below: Firm A: Debt-to-

Question

Some financial data for three corporations are displayed below:

Firm A:
Debt-to-equity ratio - 35%
Interest coverage ratio - 9 times
Price/Earnings ratio - 10 times

Firm B:
Debt-to-equity ratio - 40%
Interest coverage ratio - 11 times
Price/Earnings ratio - 12 times

Firm C:
Debt-to-equity ratio - 45%
Interest coverage ratio - 6 times
Price/Earnings ratio - 5 times

Industry Average:
Debt-to-equity ratio - 35%
Interest coverage ratio - 9 times
Price/Earnings ratio - 10 times

1. Which firm appears to be excessively leveraged?
2. Which firm seems to be employing financial leverage to the most appropriate degree?
3. How do you explain the higher P/E ratio enjoyed by firm B as compared to firm A.

Explanation / Answer

1) firm C as it has highest debt/equity ratio 2) firm A as its debt equity ratio is exactly equal to industry avg 3) that is a result of excess leverage which firm B has put itself under. it is important to note that leverage results in "magnification" of either profitability or of loss.

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