Question

Use the following financial information for Questions 1-4 below:

            From the income statement:

Depreciation expense Interest expense	$170,000 25,000
Income tax Net income	29,000 148,000

From the balance sheet:

Current liabilities	$95,000
Long-term debt	825,000
Deferred income taxes	85,000
Total Liabilities	$1,005,000
Preferred stock	8,000
Common stock	276,000
Premium on common stock	163,000
Retained earnings	678,000
Total Stockholders’ Equity	$1,125,000
Total Liabilities & Stockholders’ Equity	$2,130,000

1. What is the Times Interest Earned ratio?    _________ /_______ = ___________

2.   What is the Debt/Assets (Debt) ratio?     ________________ /___________ = __________

3. What is the Debt*/Equity ratio? ________________ /___________ = __________

*Use Long-term debt

4.   Consider the additional information for the above analysis:

1. Times Interest Earned: Compare the current year result above (better or worse) to each of the following:

i) Company prior year result of 7.0

ii) Industry average: 5.0

Interpret your findings: Are the results acceptable?   Why?

2. Debt /Equity ratio: Compare current year result above ( more or less risk) to each of the following:

i) Company prior year result of 0.8

ii) Industry average: 0.6

Interpret your findings: Are the results acceptable?   Why?

Answer 1

A Calculation of Times Interest Earned Ratio(TIER)-

TIER= EBIT/Interest expense

Calculation of EBIT-

Net Income=148,000$

Interest Expense=25,000$

Income Tax= 29000$

EBIT= 202,000$

TIER= 202,000/25,000 = 8.08 Times

B)Debt Asset Ratio=

Total Debt/Total Asset

Total Debt= Short Term Debt + Long Term Debt

Calculation of Total Debt-

Long term borrowing= 825,000$

Deffered tax liability = -(Not considered)

Current Liability= -(Not Considered)

Total Debt= $825000

Calculation of Total Asset-

Liabilities + Stockholder equity= 2,130,000$

Therefore Total Asset=2,130,000$

Debt/Asset Ratio = 825,000/2,130,000= .387 times

C Debt Equity Ratio=

Debt/Equity

=825,000/1,125,000

=.733 Times

Interpretations-

A TIER

The times interest earned (TIE) ratio is a measure of a company's ability to meet its debt obligations based on its current income. The result is a number that shows how many times a company could cover its interest charges with its pretax earnings.

A higher times interest earned ratio is favorable because it means that the company presents less of a risk to investors and creditors in terms of solvency.

Since, Existing TIER is 8.08 which is greater than last year and Industry average, results of company is acceptable and company is in a good position in respect of Interest liability.

B Debt Equity Ratio

The debt to equity ratio is a financial, liquidity ratio that compares a company's total debt to total equity. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing.

A lower Debt Equity ratio is favorable since it shows that for every 1$ of asset how much debt is taken.

Since, Existing DE Ratio is better than last year ratio but higher than industry average, Company should avoid using long term debt to finance its assets.