Question

Debt ratios measure the proportion of total assets financed by a firm’s creditors. Sunny Co. has a debt-to-equity ratio of 4.00, compared to the industry average of 3.20. Its competitor Carter Co., however, has a debt-to-equity ratio of 6.00. Based on what debt-to-equity ratios imply, which of the following statements is true? Carter Co. has greater financial risk as compared to Sunny Co. and to the average financial risk in the industry. Sunny Co.’s shareholders expect magnified returns but higher risk as compared to Carter Co. Carter Co.’s creditors face lesser risk than the average financial risk in the industry. Carter Co. has higher creditworthiness as compared to Sunny Co.

Answer 1

Answer:

Carter Co. has greater financial risk as compared to Sunny Co. and to the average financial risk in the industry.

Explanation:

Since the industry average is 3.20

Provided Debt to Equity is

Sunny Co. 4.00

Carter Co. 6.00

Since debt to equity represents the financial risk associated with the product.

It is clear that both the companies are on a higher financial risk than that of the industry.

Further the company is still in a better position than that of the competitor, as the later has higher debt to equity ratio.

Therefore, the first statement concluding that the financial risk of Carter Co. is highest of all including the competitor and the industry average is True.