A. Using the financial statements for GMT Enterprises for 2010 (given below), calculate the return on equity,

Question

the debt ratio, and the times interest earned ratio.

b. Suppose the industry average debt ratio is 50%. Give one reason why the debt ratio for GMT Enterprises
may be considered favorable, and give one reason why the debt ratio for GMT Enterprises may be considered
unfavorable.
GMT Enterprises
2010 Financial Statements
Income Statement ($)
Sales 10,000
Operating expenses 8,200
EBIT 1,800
Interest expense 100
EBT 1,700
Taxes (40%) 680
Net income 1,020
Balance Sheet ($)
Current assets 1,500
Fixed assets 4,000
Total assets 5,500
Accounts payable 900
Accruals 600
Long-term debt 400
Common stock 2,100
Retained earnings 1,500
Total liabilities & equity 5,500

Answer 1

a.
ROE = $1,020/$3,600 = 28.33%
Debt Ratio = $1,900/$5,500 = .345
Times Interest Earned = $1,800/$100 = 18
b. Favorable: lower debt means lower fixed payments, lower risk, more flexibility, and higher value; Unfavorable:
lower debt means less leverage and lower return on equity