Question

The times interest-earned ratios of Orlando, Inc. are 20.56 and 7.35 for 2018 and 2019, respectively. Which of the following can be the possible reason for such a change from 2018 to 2019? A. Orlando, Inc incurred more debt specifically in its revolving line of credit B. Orlando, Inc. incurred less debt specifically in its revolving line of credit. C. Orlando, Inc. paid less interest in its revolving line of credit D. Orlando, Inc.'s debt-paying ability increased.

Answer 1

Answer:

The correct answer is A. Orlando, Inc. incurred more debt specifically in its revolving line of credit.

Explanation:

The formula for the times interest-earned (TIE) ratio is:

TIE = Earnings Before Interest and Tax / Total Interest Payable

This ratio would decrease when the company's earnings decrease or when its interest payable increases, or when both occur simultaneously.

Considering option A, if Orlando Inc. incurs more debt in its revolving line of credit, it means it has to pay more interest. Therefore, when the company's Earnings Before Interest and Tax remain constant while its Total Interest Payable rises, its TIE ratio would fall.

This is exactly what happens as Orlando Inc.'s TIE ratio falls from 20.56 in 2018 to 7.35 in 2019. Hence, option A is correct. Options B to D would either cause the TIE ratio to rise or remain unaffected.