Question

The Morris Corporation has $350,000 of debt outstanding, and it pays an interest rate of 12% annually. Morris's annual sales are $1.75 million, its average tax rate is 40%, and its net profit margin on sales is 3%. If the company does not maintain a TIE ratio of at least 3 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:

TIE 2.47

Explanation:

$\frac{EBIT}{InterestExpense} = Times Interest Earned$

Our first step will be calculate the interest expense

350,000 debt outstanding * 12% rate = 42,000

Next, we need the EBIT which means Earnings Before Interest and Taxes.

Using the net profit margin of 3% we can get the net income

This means 3% of sales become net income

We are going to apply this to Morris sales to get the net income

$1,750,000 * 0.03 = 52,500$

Now this include the interest and taxes, we need to get the Earning before those two concepts so:

$\frac{NetIncome}{1-Tax Rate} + Interest Expense = Earnings Before Interest and Taxes$

$52,500/(1-0.40)+42,000 = 87,500 + 42,000 = 129,500$

Now we got everything needed for the TIE

129,500/52,500 = 2.47