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22nd Edition
ISBN: 9780077632878
Author: Wild
Publisher: MCG
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Chapter 11, Problem 7BTN
To determine

Times Interest Earned:

The ratio which measures a company’s ability to pay its obligation is called a times interest earned. It is computed by dividing the net income before interest and taxes by the interest expense of the company.

To determine:

1. Prepare an Income statement showing current operations, European and total when the sales at European location are $250,000.

2. Compute the times interest earned for expansion assumptions.

3. Prepare an Income statement showing current operations, European and total when the sales at European location are $400,000 and compute times interest earned.

4. Prepare an Income statement showing current operations, European and total when the sales at European location are $100,000 and compute times interest earned.

5. Comment on the results obtained in part 1 through 4.

Expert Solution & Answer
Check Mark

Answer to Problem 7BTN

Solution:

1.

    UNCHARTED PLAY
    Income Statement

    Current Operations
    European
    Total
    Sales
    $1,000,000
    $250,000
    $1,250,000
    Operating Expenses (55%)
    550,000
    137,500
    687,500
    Income before interest and tax
    450,000
    112,500
    562,500
    Interest Expense

    21,000
    21,000
    Net Income
    $450,000
    $91,500
    $541,500

2.

When sales at European location are $250,000, the times interest earned is 26.79.

3.

    UNCHARTED PLAY
    Income Statement

    Current Operations
    European
    Total
    Sales
    $1,000,000
    $400,000
    $1,400,000
    Operating Expenses (55%)
    550,000
    220,000
    770,000
    Income before interest and tax
    450,000
    180,000
    630,000
    Interest Expense

    21,000
    21,000
    Net Income
    $450,000
    $159,000
    $609,000

When sales at European location are $400,000, the times interest earned is 30.

4.

    UNCHARTED PLAY
    Income Statement

    Current Operations
    European
    Total
    Sales
    $1,000,000
    $100,000
    $1,100,000
    Operating Expenses (55%)
    550,000
    55,000
    605,000
    Income before interest and tax
    450,000
    45,000
    495,000
    Interest Expense

    21,000
    21,000
    Net Income
    $450,000
    $24,000
    $474,000

When sales at European location are $100,000, the times interest earned is 23.57.

5. The times interest earned has direct relationship with the net income of the company. With Operating expense being constant, when the net income increases due to increase in sales, the times interest earned rises and when the net income decreases due to decrease in sales, the time interest earned also falls.

Explanation of Solution

Explanation:

1.


    Current Operations
    European
    Total
    Sales
    $1,000,000
    $250,000
    $1,250,000
    55% of sale is operating expense
    55%
    55%
    55%
    Operating Expense
    $550,000
    $137,500
    $687,500

Computation of interest expense
  Principal X Rate of interest= $300,000 X 0.07= $21,000

2. When the sales are 250,000

  Times Interest Earned for Expansion =  Net Income + Interest Expense Interest Expense                                                              =  $541,500 + $21,000 $21,000                                                             = 26.79

3. When the sales are $400,000

  Times Interest Earned for Expansion =  Net Income + Interest Expense Interest Expense                                                              =  $609,000 + $21,000 $21,000                                                             = 30

4. When the sales are $100,000

  Times Interest Earned for Expansion =  Net Income + Interest Expense Interest Expense                                                              =  $474,000 + $21,000 $21,000                                                             = 23.57

Conclusion

Conclusion:

It is concluded that the times interest earned ratio depends upon the increase and decrease of net income and interest expense of a company.

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