In: Finance
Ugh Inc.’s net income for the most recent year was $15,685. The tax rate was 35 percent. The firm paid $3,856 in total interest expense and deducted $2,535 in depreciation expense. What was the cash coverage ratio for the year?
Solution:
The formula for calculating the cash coverage ratio is
= ( EBIT + Non cash expenses ) / Fixed expenses
As per the information given in the question we have
Net Income after taxes = $ 15,685
Non Cash Expenses = Depreciation = $ 2,535
Fixed Expenses = Interest Expenses = $ 3,856
Tax rate = 35 % = 0.35
Calculation of EBIT:
a.We know that
Income before taxes * ( 1 – Tax rate ) = Net Income after taxes
Applying the available information we have
Income before taxes * ( 1 – 0.35 ) = $ 15,685
Income before taxes * 0.65 = $ 15,685
Income before taxes = $ 15,685 / 0.65 = $ 24,130.7692
b.We know that
EBIT = Income before taxes + Interest expense
Applying the available information we have
= $ 24,130.7692 + $ 3,856
= $ 27,986.7692
Thus we have EBIT = $ 27,986.7692
Applying the above values in the formula we have
= ( $ 27,986.7692 + $ 2,535 ) / $ 3,856
= $ 30,521.7692 / $ 3,856
= 7.9154
= 7.92 times ( when rounded off to two decimal places )
Thus the firm’s cash coverage ratio for the year = 7.92 times.