Question

Financial​ ratios: Financial leverage. The financial statements for Tyler​ Toys, Inc. are shown below. Calculate the debt​ ratio, times interest earned​ ratio, and cash coverage ratio for 2013 and 2014 for Tyler Toys. Should any of these ratios or the change in a ratio warrant concern for the managers of Tyler Toys or the​ shareholders?

Tyler Toys, Inc.
Income Statement for Years Ending December 31, 2013 and 2014
	2014	2013
Revenue	$14,146,008	$13,566,936
Cost of goods sold	$-8,448,426	$-8,131,134
Selling, general, and administrative expenses	$-998,344	$-981,543
Depreciation	$-1,497,033	$-1,471,281
EBIT	$3,202,205	$2,982,978
Interest expense	$-375,885	$-355,036
Taxes	$-1,074,002	$-998,618
Net income	$1,752,318	$1,629,324

                                                                                                           

Tyler Toys, Inc.
Balance Sheet as of December 31, 2013 and 2014
ASSETS	2014	2013	LIABILITIES	2014	2013
Current assets			Current liabilities
Cash	$190,181	$187,027	Accounts payable	$1,546,608	$1,456,241
Investments	$181,543	$121,902	Short-term debt	$311,633	$332,971
Accounts receivable	$668,944	$631,449	Total current liabilities	$1,858,241	$1,789,212
Inventory	$588,917	$564,689	Long-term liabilities
Total current assets	$1,629,585	$1,505,067	Debt	$7,285,372	$6,603,223
Long-term assets			Other liabilities	$1,463,238	$1,346,613
Investments	$3,053,588	$2,827,617	Total liabilities	$10,606,851	$9,739,048
Plant, property, and equipment	$8,497,812	$8,481,131	OWNERS’ EQUITY
Goodwill	$347,644	$347,719	Common stock	$1,458,998	$1,454,254
Intangible assets	$1,158,701	$956,816	Retained earnings	$2,621,481	$2,925,048
			Total owners’ equity	$4,080,479	$4,379,302
			TOTAL LIABILITIES
TOTAL ASSETS	$14,687,330	$14,118,350	AND OWNERS’ EQUITY	$14,687,330	$14,118,350

What is the debt ratio for​ 2014? ________ ​(Round to four decimal​ places.)

What is the debt ratio for​ 2013? ________ ​(Round to four decimal​ places.)

What is the times interest earned ratio for​ 2014? ________ ​(Round to four decimal​ places.)

What is the times interest earned ratio for​ 2013? _______ ​(Round to four decimal​ places.)

What is the cash coverage ratio for​ 2014? ______ ​(Round to four decimal​ places.)

What is the cash coverage ratio for​ 2013? ______ ​(Round to four decimal​ places.)

Should any of these ratios or the change in a ratio warrant concern for the managers of Tyler Toys or the​ shareholders? (Select the best​ response.)

A. The debt ratio is very high and would warrant concern if the cash coverage ratio or the times interest earned ratio was​ high, but with low ratios this means they are handling their large debt well.

B. The debt ratio is very low and would warrant concern if the cash coverage ratio or the times interest earned ratio was​ high, but with low ratios this means they are handling their large debt well.

C. The debt ratio is very high and would warrant concern if the cash coverage ratio or the times interest earned ratio was​ low, but with high ratios this means they are handling their large debt well.

D. The debt ratio is very low and would warrant concern if the cash coverage ratio or the times interest earned ratio was​ low, but with high ratios this means they are handling their large debt well.

Answer 1

(1) Calculation of debt ratio

Debt Ratio = Total Liabilities/ Total Assets

2013:

$97,39,048/$14,118,350 = 0.6898

2014:

$10,606,851/$14,687,330 = 0.7221

(2) Times Interest Earned Ratio = EBIT/ Interest Expenses

2013:

$2,982,978/ $355,036 = 8.4019

2014:

$3,202,205 / $ 375,885 = 8.5191

(3) Cash coverage ratio = EBIT+ Depreciation/ Interest Expenses

2013:

$2,982,978 + $1,471,281 / $355,036

= 44,54,259/ 355,036 = 12.5459

2014:

$3,202,205 + $1,497,033 / $375,885

= $ 46,99,238/ $375,885= 12.5017

The correct response is C "The The debt ratio is very high and would warrant concern if the cash coverage ratio or the times interest earned ratio was​ low, but with high ratios this means they are handling their large debt well". The company's debt is quite high but due to good earnings of the company, the company is capable enough to meet the interest expenses in an effective way, which is suggested by high cash coverage and times interest earned ratio by the company.