Question

The Morris Corporation has $300,000 of debt outstanding, and it pays an interest rate of 8% annually. Morris's annual sales are $1.5 million, its average tax rate is 40%, and its net profit margin on sales is 4%. If the company does not maintain a TIE ratio of at least 4 to 1, then its bank will refuse to renew the loan, and bankruptcy will result. What is Morris's TIE ratio? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Answer: 1.41

Explanation:

Given that,

Debt outstanding = $300,000

interest rate = 8% annually

annual sales = $1.5 million

average tax rate = 40%

net profit margin on sales = 4%

interest amount = 300,000 × 0.08

                          = $24,000

net profit = 4% of 1.5 million

                = $6,000

Profit before tax = $\frac{6,000}{0.60}$

                           = $10,000

earning before interest and tax = profit before tax + interest

                                                    = $10,000 + $24,000

                                                    = $34,000

TIE ratio = $\frac{EBIT}{Interest}$

              = $\frac{34,000}{24,000}$

              = 1.41