Question

You are the loan manager for a local commercial bank and was approached by the management of Intel Corp.for a $150,000 loan to be used in the expansion of its business.  You requested and have received the following financial information to be used as the basis for your decision:

Intel Corp.
Income Statement
Selected Financial	FY 2017	FY 2018	FY 2019
EBIT	20,352	23,317	24,058
Interest Expense	349	126	484
Income Tax Expense	10,751	2,264	3,010

A. Please calculate the Times Interest Earned ratio for FY 2017, 2018, and 2019.

Formula:   EBIT + Interest Expense + Income Tax Expense

Interest Expense

B. Based on your calculation in (A), was the ratio good or bad between FY 2017 to FY 2018, and between FY 2018 to FY 2019? Please explain in two paragraphs.

Answer 1

Amounts are in $

(A)

Times Interest Earned = EBIT/Interest Expense

For 2017 : 20,352/349 = 58.32 times

For 2018 : 23,317/126 = 185.06 times

For 2019 : 24,058/484 = 49.71 times

Note : The formula given in the question is not clear, so the formula which is widely used for calculating Times interest earned is used here.

(B)

The times interest earned ratio is good when the answer is higher.

The ratio has become better in 2018 (185.06 times) from 2017 (58.32 times).

The ratio has worsened in 2019 (49.71 times) from 2018 (185.06 times).

So, the ratio is best in 2018 with 185.06 times (highest of three years) and lowest in 2019 (49.71 times)

Note :

The given formula seems to be

(EBIT + Interest + Income tax)/Interest expense

There is a flaw in this formula, we need not add interest and income tax to EBIT as they are not all reduced while computed EBIT (Earnings Before Interest and Tax). If it is PAT then we would have added Interest and Income tax.

So we have taken the widely used formula for Times Interest Earned (which is correct)

Times Interest Earned = EBIT/Interest Expense

This shows how many times the interest expense the firm is generating as income.