Question

In: Finance

If the interest coverage ratio is too high, then the ROE is too low, Agree or...

If the interest coverage ratio is too high, then the ROE is too low, Agree or Not ?
What the three factor affect ROE and how higher ROE lead to higher share price ?

Solutions

Expert Solution

1.NO.Do not agree.
Interest coverage ratio=EBIT/Interest expense
Return on Equity=Net income/Total Equity
If interest coverage ratio is too high, it means that either
1.EBIT, ie Earnings before interest & taxes is high OR
2.Interest expense is low.
In both the above cases, net income will be increasing .(EBIT-Int.-Taxes)
Hence ROE wil not be too low.
2. Three factors that affect ROE
According to the DuPont equation for ROE,
ROE= Profit margin*Total assets turnover*Financial leverage
so, 1.the level of profit margin to sales--ie. Operational efficiency
2. the level of $ sales that is generated by deploying per $ of the assets-- the assets usage efficiency &
3. the level of debt in funding the assets, the optimium the better--
are the three main factors that drive the return to equity
Higher ROE lead to higher share price
as incresaing ROE is an indication of good returns on the equity capital
as well as better usage of the equity funds
thus instilling confidence in the potential investors to invest funds in the company.
Thus the demand for the company's shares goes up in the market
pushing up the stock prices

Related Solutions

How can a company with a high ROE have a low P/E ratio?
How can a company with a high ROE have a low P/E ratio?
What is your opinion of the minimum wage? Is it too high or too low? Explain....
What is your opinion of the minimum wage? Is it too high or too low? Explain. If the current minimum wage is above what the market would ordinarily bear (equilibrium wage in that market), and there is a proposal to raise the wage, explain the economic effects of the proposal on wages, employment, product prices and costs of the products the minimum wage labor produces (a graph may be useful here). How important is the assumption of the proposed wage...
The typical American diet is too high in saturated fat, sodium, and sugar and too low...
The typical American diet is too high in saturated fat, sodium, and sugar and too low in fruits, vegetables, whole grains, calcium, and fiber. Such a diet significantly increases the risk of numerous diseases, including heart disease, diabetes, obesity, hypertension, stroke, osteoporosis, and many cancers (colon, prostate, mouth, throat, lung, stomach). Overall, unhealthy eating habits and inactivity affect quality of life and cause disabilities. What do you think needs to be done in order to reduce the intake of saturated...
1)Sometimes called the coverage ratio, this ratio measures the risk that interest payments will not be...
1)Sometimes called the coverage ratio, this ratio measures the risk that interest payments will not be made if earnings decrease. a. Number of days' sales in inventory b. Times interest earned ratio c. Ratio of fixed assets to long-term liabilities d. Ratio of liabilities to stockholders' equity 2)The balance sheets at the end of each of the first two years of a company's operations indicate the following: Year 2 Year 1 Total current assets $600,000 $580,000 Total investments 80,000 40,000...
1.The interest-coverage ratio is calculated as a) net income + taxes – interest - depreciation) ÷...
1.The interest-coverage ratio is calculated as a) net income + taxes – interest - depreciation) ÷ interest. b) (net income – taxes – interest – depreciation) ÷ interest. c) net income + taxes + interest + depreciation) ÷ interest. d) net income + interest + depreciation) ÷ interest. 2. All of the following transactions lead to temporary timing differences except a) the use of straight-line depreciation of accounting purposes. b) the recognition of dividend income for dividends received from another...
How can the company increases it's interest coverage ratio ? Explain
How can the company increases it's interest coverage ratio ? Explain
Ratios: Current Ratio: 3.6093 Quick Ratio:                           2.1799 Times Interest Earned: 9.9143 ROE &nbs
Ratios: Current Ratio: 3.6093 Quick Ratio:                           2.1799 Times Interest Earned: 9.9143 ROE                                        16.48% ROA                                        12.01% Equity Multiplier                    1.3714 Inventory Turnover 1.3489 The DuPont Identity helps us to better understand why a firm might have a poor ROE (Return on Equity).  We can write the DuPont Identity as follows: ROE = (Net Income / Sales)(Sales / Assets)(Assets / Owner's Equity) Based on this, which of the following statements are true? Select one: a. If Sales remained constant but Net Income fell, the ROE would rise, ceteris...
java beginner level how do i add messages that say win, too high or too low...
java beginner level how do i add messages that say win, too high or too low for a lottery number generator guessing game? //generate lottery numbers int lottery = (int) (Math.random() * 500); int guess = 0; boolean correct = false; // prompt user to enter a guess Scanner input = new Scanner(System.in); System.out.print ("Enter your lottery pick (three digits): "); int number = input.nextInt(); // keep asking user until user enters a 3-digit number while (guess < 100 ||...
In general, which is better, high liquidity ratio values or low liquidity ratio values? Is it...
In general, which is better, high liquidity ratio values or low liquidity ratio values? Is it possible for the current and quick ratio values to get too large? How might this occur? What problem does it indicate the firm may be experiencing?​
If a firm has a high current ratio but a low acid-test ratio, one can conclude...
If a firm has a high current ratio but a low acid-test ratio, one can conclude that: a the firm has a large outstanding accounts receivable balance. b the firm has a large investment in inventory. c the firm has a large amount of current liabilities. d the firm's financial leverage is very high.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT