Leverage Ratios

Question 1

Equity Multiplier or
Leverage Factor

Amount of total assets financed by equity. The
higher the ratio, the greater is the leverage
(assets financed by debt) and the greater the
risk.

Answer 1

Average Total Assets
/Average Common Equity

Question 2

Financial Leverage Ratio

Measures the risk associated in using debt to
finance investments.

Answer 2

EBIT
/EBIT – Interest expense – preferred
dividend before tax

Question 3

Financial Leverage Index

If the index exceeds 1.0, it is favorable and the
use of financial leverage is successful.

Answer 3

Return on Common Equity
/Return on Assets

Question 4

Interest-Bearing Debt
Ratio

Measures the extent to which the assets having
explicit cost (total capital) are financed by
interest-bearing debt.

Answer 4

Interest – Bearing Debt
/Equity + Interest – Bearing Debt

Question 5

Total Debt Ratio

Measures the percentage of funds provided by
creditors.

Answer 5

Total Liabilities
/Total Assets

Question 6

Debt Ratio to Equity

Compares resources provided by creditors with
resources provided by shareholders.
Measures the use of debt to finance operations.

Answer 6

Total Liabilities
/Equity

Question 7

Times Interest-earned
Ratio or Interest
Coverage Ratio

Indicates the margin of safety for payment of
fixed interest charges,
Measures the long-term debt paying ability of the
firm; a high number of times interest is earned
ratio indicates that the business is underleveraged and its return on common equity could
still be improved; EBIT=earnings before interest
and taxes

Answer 7

Earnings before interest and Tax (EBIT)
/Interest Expense

Question 8

Equity to Assets Ratio

Measures the amount of resources provided by
the owners of the firm.

Answer 8

Net Stockholder’s Equity
/Total Assets