Question

According to the producer price index database maintained by the Bureau of Labor Statistics, the average cost of computer equipment fell 3.8 percent between January and December 2016. Let's see whether these changes are reflected in the income statement of Computer Tycoon Inc. for the year ended December 31, 2016.
2016 2015
Sales Revenue $ 109,000 $ 133,500
Cost of Goods Sold 64,500 75,100
Gross Profit 44,500 58,400
Selling, General, and Administrative Expenses 36,900 38,800
Interest Expense 590 520
Income before Income Tax Expense 7,010 19,080
Income Tax Expense 1,500 5,900
Net Income $ 5,510 $ 13,180
Required:
1. Compute the times interest earned ratios for 2016 and 2015. (Round your answers to 1 decimal place.) Times Interest Earned 2015 2016
2. Does Computer Tycoon generate sufficient net income in both years before taxes and interest) to cover the cost of debt financing?
a. Yes
b. No

Answer 1

Answer:

A.

2015 37.7

2016 12.9

B. Yes

Explanation:

Computation of the times interest earned ratios for 2016 and 2015

First step is to find the EBIT

EBIT: 2016 $ 2015 $

Gross profit 44,500 58,400

Less Selling, General and Administrative expenses (36,900) (38,800)

EBIT 7,600 19,600

Second step is to compute the times interest earned ratios for 2016 and 2015 using this formula

Time interest earned = EBIT / Interest expense

Let plug in the formula

Time interest earned 2016 2015

EBIT $7,600 $19,600

÷Interest expense $590 $520

=Time interest earned 12.9 37.7

Therefore the Time interest earned will be :

2015 37.7

2016 12.9

2. Yes Computer Tycoon generate sufficient net income in both 2015 and 2016 before taxes and interest in order to cover the cost of debt financing.