Question

Selected financial statement data (in $ thousands) for KRJ Enterprises are listed below, calculate the interest coverage ratio. Present your answer rounded to two decimal places. e.g. 20.00. Sales $10,183

Cost of goods sold 5,676

Cash operating expenses 1,844

Depreciation expense 497

Interest expense 174

Tax expense 213

Footnotes report that $240 of lease expenses are included in cash operating expenses, $26 of interest expenditures were capitalized during the year, and $538 of debt was repaid during the year.

Answer 1

Interest Coverage Ratio = EBIT / Interest Expense

Where, EBIT = Earnings before Interest and Taxes

Interest Expense = $ 174 + $26

= $ 200

Note : $ 26 of Interest Expenditure which is Capitalized during the year will also be considered because $ 26 is Interest expense irrespective of the fact that is is revenue or capital in nature.

For EBIT , first we need to calculate the Operating Expenses :

Operating Expenses = Cash Operating Expenses - Interest Expenditure - Debt repaid

= $ 1,844 - $ 26 - $ 538

= $ 1,280

Now, Earnings = Sales - Cost of goods sold - operating expenses - Depreciation

= $ 10,183 - 5,676 - $ 1,280 - $497

= $ 2,730

So, Net earnings computed of $ 2,730 is EBIT

EBIT = Earnings before Interest, Taxes, Depreciation and Amortization

EBIT = $ 2,730

Note : Interest Expenses as computed is part of Interest Expenses and Debt repaid is a capital expenditure so is not part of Profit and Loss statement of KRJ enterprises.

But yes, Lease expenses are part of Profit and loss item .

Interest Coverage Ratio = EBIT / Interest Expense

= $ 2,730 / $ 200

= $ 13.65

Conclusion : Interest Coverage Ratio indicates that how many times the company is able to cover its Interest Expense form the Earnings.

So, 13.65 times KRJ enterprises has the capacity to pay its Interest expense from the earnings.