Question

Omnimenium, an automobile company, incurred a debt of $20 million for the fiscal year of 2016. The company used that money with an additional $20 million of its own to buy out a rival company. The ratio of the company's debt to its investment is 0.5. The given scenario illustrates the analysis of _____.

Answer 1

Answer:

Leverage Ratios

Explanation:

Leverage ratios signify the proportion of debt. The purpose behind calculating such ratios and their interpretation being to assess an entity's reliance on debt for raising long term capital.

Debt to investments ratio would be the proportion of debt used in the total investment made by a company.

Debt to investments ratio is computed as : $\frac{Amount\ of \ debt\ used}{Total\ investments }$

In the given case, the company utilized it's funds from debt to the tune of $20 million for it's investments in buying out another company.

Total investments = $ 20 million in debt + $20 million own funds i.e retained profits = $40 million

Out of $40 million, $20 million has been financed by debt.

Thus, Debt to investments ratio is 0.5.

Lower the debt to investment ratio, better it is for the company since lower will be interest and principal repayment obligations.