Price Printing Co. had sales of $10 million, operating income of $3 million, after-tax income of $1 million, assets of $8 million, stockholders' equity of $5 million, and a total debt of $3 million. If we measure Price's financial leverage, we would most likely use which of the following ratios from chapter 8?
A)Debt-to-equity (60%) and debt-to-sales (30%)
B)Debt-to-equity (60%) and equity-to-assets (62.5%)
C)Debt-to-equity (60%) and debt-to-assets (37.5%)
D)Equity-to-assets (62.5%) and after-tax income-to-debt (33.3%)

Question

Quizplus · Accepted Answer

To measure financial leverage, we need to see the proportion of debt and equity in a company's capital structure. Debt-to-equity (D/E) and debt-to-assets (D/A) ratios are helpful in this regard. A high D/E ratio or D/A ratio indicates that a company has more debt than equity/assets in its capital structure, indicating high leverage. Choice C is the correct answer as it provides the D/E ratio (60%) and D/A ratio (37.5%) for Price Printing Co., which indicates that the company is leveraging more towards debt than equity. Choice A and B provide the D/E ratio, but they do not have the D/A ratio. Choice D provides the equity-to-assets ratio, which is not relevant to measure leverage. Additionally, the after-tax income-to-debt ratio does not provide any information on the proportion of debt and equity in the capital structure.