How is debt capacity calculated?

Debt capacity is an essential measure used to assess how much debt a company can sustain while maintaining its operations and financial health. The correct answer encompasses the process of determining debt capacity through various financial metrics. By multiplying EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) by a valuation multiple, you are estimating the company's overall value and financial stability. Adding cash to this calculation provides a more comprehensive view of the company's available resources to service debt.

This approach reflects the operational performance and overall market valuation of the company, allowing lenders to evaluate how much debt the entity can responsibly manage without jeopardizing its financial viability. Understanding debt capacity in this manner is crucial, as it considers both the company's earning potential (reflected in EBITDA) and cash reserves, providing a clearer indication of the sustainable leverage the company can undertake.

The other options do not effectively represent a robust method for calculating debt capacity. For instance, calculating EBITDA divided by liabilities does not offer a direct insight into a company's ability to manage additional debt. Similarly, total revenue minus operating costs does not account for the broader financial picture needed for debt assessment. Lastly, net income plus depreciation focuses on past performance without factoring in broader operational metrics relevant for assessing future borrowing potential.