Question

In: Finance

In 2016, Natural Selection, a nationwide computer dating service, had $510 million of assets and $205...

In 2016, Natural Selection, a nationwide computer dating service, had $510 million of assets and $205 million of liabilities. Earnings before interest and taxes were $125 million, interest expense was $28.5 million, the tax rate was 40 percent, principal repayment requirements were $24.5 million, and annual dividends were 40 cents per share on 20.5 million shares outstanding.

a. Calculate the following for Natural Selection: (Round your answers to 2 decimal places.)

-Liabilities to equity ratio

-Times interest earned ratio

-Times burden covered

b. What percentage decline in earnings before interest and taxes could Natural Selection have sustained before failing to cover: (Round your answers to 1 decimal place.)

-Interest payment requirements

-Principal and interest requirements

-Principal and interest and common dividend payments

Expert Solution

Answer :

a) Calculation of Liabilities-to-equity ratio :

Liabilities = $ 205 million

Equity = Assets - Liabilities

= $ 510 million - $ 205 million

= $ 305 million

Therefore, Liabilities-to-equity ratio = Liabilities / Equity

= $ 205 million / $ 305 million = 0.672

Times-interest-earned ratio = EBIT / Interest expense

= $ 125 million / $ 28.5 million = 4.39

Times burden covered = EBIT / [ interest expense + principal payment / ( 1 - tax rate ) ]

= $ 125 / [ $28.5 + 24.5 / ( 1 - 40% ) ] = 1.803

b) Interest payment requirements:

EBIT needs to be declined from $ 125 million to below $ 28.5 million to fail to cover the interest expense

= ( $125 - $28.5 ) / 125 * 100 = 77.20% decline in EBIT

Principal and interest requirements:

EBIT needs to be declined from $ 125 million to below $ 69.33 million to fail to recover principal and interest

= ( $125 - $69.33 ) / 125 * 100 = 44.54%

Principal and interest and common dividend payments:

EBIT needs to be declined from $ 125 million to below [ 28.5 + 24.5 / ( 1 - 40% ) + ( 0.40 * 20.5) / ( 1 - 40% ) ]

= $ 83 to fail to cover principal,interest and common dividend payments

= ( $ 125 - $ 83 ) / 125 * 100 = 33.6%

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