Question

TIE AND ROIC RATIOS

The W.C. Pruett Corp. has $800,000 of interest-bearing debt outstanding, and it pays an annual interest rate of 12%. In addition, it has $600,000 of common stock on its balance sheet. It finances with only debt and common equity, so it has no preferred stock. Its annual sales are $2.56 million, its average tax rate is 40%, and its profit margin is 3%. What are its TIE ratio and its return on invested capital (ROIC)? Round your answers to two decimal places.

TIE :

ROIC:  %

Answer 1

Note 1 : Calculation of net income :

Net income = Sales * Profit margin @ 3%

Here

Sales = $2.56 million or $2,560,000

Net profit margin = 3%

Now,

Net income = $2,560,000 * 3% = $76,800

Note 2 : Calculation Of Earnings before interest and tax (EBIT)

EBIT = (Net income / (1 - Tax rate)) + Interest

Here,

Net income (refer note 1) = $76,800

Tax rate = 40% or 0.40

Interest = Debt * Interest rate @ 12%

Interest = $800,000 * 12% = $96,000

Now put the values into formula,

EBIT = ($76,800 / (1 - 0.40)) + $96,000

EBIT = ($76,800 / 0.60) + $96,000

EBIT = $128,000 + $96,000

EBIT = $224,000

1) TIE (tines interest earned) = EBIT / Interest

Here,

EBIT (refer note 2) = $224,000

Interest (refer note 2) = $96,000

Now

TIE = $224,000 / $96,000

TIE = 2.33 times

2) ROIC (return on invested capital) = ( Net income - Dividend) / (Debt + Equity)

Here,

Net income (refer note 1) = $76,800

Dividend = Nil

Debt (given) = $800,000

Equity (given) = $600,000

Now put the values into formula,

ROIC = ($76,800 - 0) / ($800,000 + $600,000)

ROIC = $76,800 / $1,400,000

ROIC = 0.0549 or 5.49%