Question

olvency Analysis

The following information is available from the balance sheets at the ends of the two most recent years and the income statement for the most recent year of Impact Company:

		December 31
		2017		2016
Accounts payable		$ 65,000		$ 50,000
Accrued liabilities		25,000		35,000
Taxes payable		60,000		45,000
Short-term notes payable		0		75,000
Bonds payable due within next year		200,000		200,000
Total current liabilities		$ 350,000		$ 405,000
Bonds payable		$ 600,000		$ 800,000
Common stock, $10 par		$1,000,000		$1,000,000
Retained earnings		650,000		500,000
Total stockholders’ equity		$1,650,000		$1,500,000
Total liabilities and stockholders’ equity		$2,600,000		$2,705,000

		2017
Sales revenue		$1,600,000
Cost of goods sold		950,000
Gross profit		$ 650,000
Selling and administrative expense		300,000
Operating income		$ 350,000
Interest expense		89,000
Income before tax		$ 261,000
Income tax expense		111,000
Net income		$ 150,000

Other Information:

1. Short-term notes payable represents a 12-month loan that matured in November 2017. Interest of 12% was paid at maturity.
2. One million dollars of serial bonds had been issued ten years earlier. The first series of $200,000 matured at the end of 2017, with interest of 8% payable annually.
3. Cash flow from operations was $185,000 in 2017. The amounts of interest and taxes paid during 2017 were $89,000 and $96,000, respectively.

Required:

1. Compute the following for Impact Company. Round your answers to two decimal places.

	2017		2016
a. The debt-to-equity ratio at December 31, 2017, and December 31, 2016		to 1		to 1
b. The times interest earned ratio for 2017		to 1
c. The debt service coverage ratio for 2017		times

Answer 1

a)

Debt to equity ratio = Total liabilities/Equity

2016

Debt = Short-term notes payable + Bonds payable due within next year + Bonds payable

= 75,000 + 200,000 + 800,000

= $1,075,000

Stockholders' equity = $1,500,000

Debt to equity ratio (2016) = 1,075,000/1,500,000

= 0.72:1

2017

Debt = Bonds payable due within next year + Bonds payable

= 200,000 + 600,000

= $800,000

Stockholders' equity = $1,650,000

Debt to equity ratio (2017) = 800,000/1,650,000

= 0.48:1

b)

Times interest earned = Profit before interest/Interest

= 350,000/89,000

= 3.93:1

c)

Total debt service = Short term note payable + Interest on short term note payable + Bonds payable due in the current year + Interest on bonds payable due

= 75,000 + 75,000 x 12% + 200,000 + 200,000 x 8%

= 75,000 + 9,000 + 200,000 + 16,000

= $300,000

Debt service coverage ratio = Net operating income/Total debt service

= 350,000/300,000

= 1.17 times

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