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Times Interest Earned:
Times interest earned measures whether the company is in position to pay its debt obligations or not. It is also known as interest coverage ratio.
1.
To compute: Times interest earned of M Company.
Explanation of Solution
Given,
For M company
Income before interest is $200,000.
Interest expense is $60,000.
Times interest earned
Formula to calculate times interest earned,
Substitute $200,000 for income before interest and tax and $60,000 for interest expense.
Thus, times interest earned of M Company is 3.33 times.
2.
To compute: Times interest earned of W Company.
2.
Explanation of Solution
Given,
For W company
Income before interest is $400,000.
Interest expense is $260,000.
Times interest earned
Formula to calculate times interest earned,
Substitute $400,000 for income before interest and tax and $260,000 for interest expense.
Thus, times interest earned of W company is 1.54 times.
3.
To compute: Net income if sales increase by 30%.
3.
Explanation of Solution
Net income if sales increase by 30%.
| Particulars | M Company ($)(given) | M Company ($)(30% increased sales) | W Company ($)(given) | W Company ($)(30% increased sales) |
| Sales | 1000,000 | 1,300,000 | 1,000,000 | 1,300,000 |
| Variable expenses | 800,000 | 1,040,000 | 600,000 | 780,000 |
| Income before interest | 200,000 | 260,000 | 400,000 | 520,000 |
| Interest expense | 60,000 | 60,000 | 260,000 | 260,000 |
| Net income | 140,000 | 200,000 | 140,000 | 260,000 |
| Increase in net income | 43% | 86% |
Table (1)
Working note:
Formula to calculate percentage increase in net income,
For Company M
For Company W
Thus, net income of Company M gets increased by 43% and Company W by 86%.
4.
To compute: Net income if sales increase by 50%.
4.
Explanation of Solution
Net income if sales increase by 50%.
| Particulars | M Company ($)(given) | M Company ($)(50% increased sales) | W Company ($)(given) | W Company ($)(50% increased sales) |
| Sales | 1000,000 | 1,500,000 | 1,000,000 | 1,500,000 |
| Variable expenses | 800,000 | 1,200,000 | 600,000 | 900,000 |
| Income before interest | 200,000 | 300,000 | 400,000 | 600,000 |
| Interest expense | 60,000 | 60,000 | 260,000 | 260,000 |
| Net Income | 140,000 | 240,000 | 140,000 | 340,000 |
| Increase in net income | 71% | 143% |
Table (1)
Working Note:
Formula to calculate percentage increase in net income,
For Company M
For Company W
Thus, net income of Company M gets increased by 71% and Company W by 143%.
5.
To compute: Net income if sales increase by 80%.
5.
Explanation of Solution
Net income if sales increase by 80%.
| Particulars | M Company ($)(given) | M Company ($)(80% increased sales) | W Company ($)(given) | W Company ($)(80% increased sales) |
| Sales | 1000,000 | 1,800,000 | 1,000,000 | 1,800,000 |
| Variable expenses | 800,000 | 1,440,000 | 600,000 | 1,080,000 |
| Income before interest | 200,000 | 360,000 | 400,000 | 720,000 |
| Interest expense | 60,000 | 60,000 | 260,000 | 260,000 |
| Net Income | 140,000 | 300,000 | 140,000 | 460,000 |
| Increase in net income | 114% | 229% |
Table (1)
Working Note:
Formula to calculate percentage increase in net income,
For Company M
For Company W
Thus, net income of Company M gets increased by 114% and Company W by 229%.
6.
To compute: Net income if sales decrease by 10%.
6.
Explanation of Solution
Net income if sales decrease by 10%.
| Particulars | M Company ($)(given) | M Company ($)(10% decreased sales) | W Company ($)(given) | W Company ($)(10% decreased sales) |
| Sales | 1000,000 | 900,000 | 1,000,000 | 900,000 |
| Variable expenses | 800,000 | 720,000 | 600,000 | 540,000 |
| Income before interest | 200,000 | 180,000 | 400,000 | 360,000 |
| Interest expense | 60,000 | 60,000 | 260,000 | 260,000 |
| Net Income | 140,000 | 120,000 | 140,000 | 100,000 |
| Increase in net income | -14% | -29% |
Table (1)
Working note:
Formula to calculate percentage increase in net income,
For Company M
For Company W
Thus, net income of Company M gets decreased 14% and Company W by 29%.
7.
To compute: Net income if sales decrease by 20%.
7.
Explanation of Solution
Net income if sales decrease by 20%.
| Particulars | M Company ($)(given) | M Company ($)(20% decreased sales) | W Company ($)(given) | W Company ($)(20% decreased sales) |
| Sales | 1000,000 | 800,000 | 1,000,000 | 800,000 |
| Variable expenses | 800,000 | 640,000 | 600,000 | 480,000 |
| Income before interest | 200,000 | 160,000 | 400,000 | 320,000 |
| Interest expense | 60,000 | 60,000 | 260,000 | 260,000 |
| Net Income | 140,000 | 100,000 | 140,000 | 60,000 |
| Increase in net income | -29% | -57% |
Table (1)
Working Note:
Formula to calculate percentage increase in net income,
For Company M
For Company W
Thus, net income of Company M gets decreased 29% and Company W by 57%.
8.
To compute: Net income if sales decrease by 40%.
8.
Explanation of Solution
Net income if sales decrease by 40%.
| Particulars | M Company ($)(given) | M Company ($)(40% decreased sales) | W Company ($)(given) | W Company ($)(40% decreased sales) |
| Sales | 1000,000 | 600,000 | 1,000,000 | 600,000 |
| Variable expenses | 800,000 | 480,000 | 600,000 | 360,000 |
| Income before interest | 200,000 | 120,000 | 400,000 | 240,000 |
| Interest expense | 60,000 | 60,000 | 260,000 | 260,000 |
| Net Income | 140,000 | 60,000 | 140,000 | (20,000) |
| Increase in net income | -57% | -114% |
Table (1)
Working note:
Formula to calculate percentage increase in net income,
For Company M
For Company W
Thus, net income of Company M gets decreased 57% and Company W by 114%.
9.
Relation to fixed cost strategies of the two companies.
9.
Explanation of Solution
Relation to fixed cost strategies of the two companies,
- Here in this case fixed cost refers to interest expenses.
- Interest expenses in Company M are $ 60,000 and in Company W are $260,000. Interest expenses are higher in company W than in Company M.
- Due to higher interest expenses, change in net income gets more effected due to change in sales.
- Higher fixed cost is inversely related to times interest earned method.
- So if sales get increased, W Company enjoys higher percent increase in income in comparison to Company M.
- If sales get decreased, M Company experiences smaller percent change in net income in comparison to Company W.
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