Question

6. A firm’s times interest earned ratio is 3 but its cash flow to long-term debt ratio is only 0.75. Taken together, does this information mean that a long-term lender should be concerned about lending this firm money long term?

Answer 1

Yes, long term debt ratio of 75% means that only 25% assets are financed through equity, which means debt to equity ratio is 3. Also interest earned ratio is the ratio of EBIT by interest expense. An interest earned ratio of only 3 means that pays 1/3 of its earnings before interest and taxes in interest already.

It means that the capacity of the firm to borrow more money is weak and hence, a long-term lender should be concerned about lending money to this firm.