Question

Alumbat Corporation has $800,000 in debt outstanding, and pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000, its average tax rate is 40 percent, and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. Alumbat's current times interest earned ratio is:

Answer 1

Answer: 5.0

Explanation:

Times interest earned ratio = Earnings before Interest and Tax / interest

Interest = 800,000 * 10%

= $80,000

Net Income = 6% of sales

= 6% * 3,200,000

= $192,000

Taxes are accounted for already so to get the taxable income;

Earnings before tax = 192,000 / ( 1 - Tax rate)

= 192,000 / ( 1 - 0.4)

= $320,000

Earnings before Interest and Tax = 320,000 + 80,000

= $400,000

Times interest earned ratio = 400,000/80,000

= 5.0