Deck 7: Long-Term Debt-Paying Ability

Question 1

Which of the following statements is not true relating to a capitalized (capital)lease?

A)A capital lease is handled as if the lessee bought the asset.
B)The leased asset is in the fixed assets and the related obligation is included in liabilities.
C)On the balance sheet,the capitalized asset amount will not usually agree with the capitalized liability amount because the liability is reduced by payments,and the asset is reduced by depreciation taken.
D)Usually,a company depreciates capitalized leases faster than payments are made.
E)On the balance sheet,the capitalized asset amount will usually be higher than the capitalized liability amount.

Answer 1

E

Question 2

Joseph and John,Inc. ,had the following balance sheet results for 2012:
$\begin{array}{lccc}&\text { (in millions) }\\ \text {Current liabilities } &\$12.6 \\ \text {Bonds payable } &18.6\\ \text { Lease obligations} &2.7\\ \text {Noncontrolling interest } &1.4\\ \text {Common stock } &8.6\\ \text {Retained earnings } &\underline{22.9}\\&\underline{\$66.8}\end{array}$


Compute the debt-equity ratio.

A)112.1%
B)87.6%
C)67.6%
D)46.7%
E)none of the answers are correct

Answer 2

112.1%

Question 3

There are a number of assumptions about future events that must be made regarding a defined benefit plan.An assumption that does not need to be made is:

A)interest rates.
B)employee turnover.
C)mortality rates.
D)compensation.
E)how long the firm will continue.

Answer 3

E

Question 4

Ingram Dog Kennels had the following financial statistics for 2012:
$\begin{array}{llcc} \text {Long-term debt (average rate of interest is \( 8 \% \) ) } &\$400,000 \\ \text { Interest expense } &35,000\\ \text { Net income } &48,000\\ \text { Income tax } &46,000\\ \text {Operating income } &107,000\\\end{array}$

What is the times interest earned for 2012?

A)11.4 times
B)3.3 times
C)3.1 times
D)3.7 times
E)None of the answers are correct.

Question 5

The debt ratio indicates:

A)the ability of the firm to pay its current obligations.
B)the efficiency of the use of total assets.
C)the magnification of earnings caused by leverage.
D)a comparison of liabilities with total assets.
E)none of the answers are correct.

Question 6

Jordan Manufacturing reports the following capital structure:
$\begin{array}{llcc} \text { Current liabilities } & \$100,000 \\ \text { Long-term debt } &400,000\\ \text {Deferred income taxes } &10,000\\ \text { Preferred stock } &80,000\\ \text {Common stock } &100,000\\ \text { Premium on common stock } &180,000\\ \text { Retained earnings } &170,000\\\end{array}$

What is the debt ratio?

A)0.48
B)0.49
C)0.93
D)0.96
E)None of the answers are correct.

Question 7

The following financial statement data are taken from Xeron Company's 2012 annual report:
$\begin{array}{lccc}&\text { (in millions) }\\ \text {Current assets } & \$12.8\\ \text {Investments } &9.4\\ \text { Intangibles } &6.8\\ \text {Property, plant, and equipment } &58.1\\ \text { Current liabilities } &6.4\\ \text { Long-term debt} &39.7\\ \text {Stockholders' equity } &40.8\end{array}$

Compute the debt ratio.

A)196.9%
B)113.0%
C)53.0%
D)45.7%
E)none of the answers are correct

Question 8

Which of the following will not cause times interest earned to drop? Assume no other changes than those listed.

A)An increase in bonds payable with no change in operating income.
B)An increase in interest rates.
C)A rise in preferred stock dividends.
D)A rise in cost of goods sold with no change in interest expense.
E)A drop in sales with no change in interest expense.

Question 9

Which of the following statements best compares long-term borrowing capacity ratios?

A)The debt/equity ratio is more conservative than the debt ratio.
B)The debt ratio is more conservative than the debt/equity ratio.
C)The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
D)The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
E)The debt ratio is more conservative than the debt to tangible net worth ratio.

Question 10

Jones Company has long-term debt of $1,000,000,while Smith Company,Jones' competitor,has long-term debt of $200,000.Which of the following statements best represents an analysis of the long-term debt position of these two firms?

A)Smith Company's times interest earned should be lower than Jones.
B)Jones obviously has too much debt when compared to its competitor.
C)Jones should sell more stock and use less debt.
D)Smith has five times better long-term borrowing ability than Jones.
E)Not enough information to determine if any of the answers are correct.

Question 11

Under the Employee Retirement Income Security Act,a company can be liable for its pension plan up to:

A)30 percent of its total assets
B)30 percent of its net worth
C)40 percent of its total assets
D)40 percent of its net worth
E)50 percent of its total assets

Question 12

A times interest earned ratio indicates that:

A)preferred stock has no maturity date.
B)the debt will never become due.
C)the firm will be able to repay the principal when due.
D)the principal can be refinanced.
E)none of the answers are correct.

Question 13

The following financial statement data are taken from Xeron Company's 2012 annual report:
$\begin{array}{lccc}&\text { (in millions) }\\ \text {Current assets } & \$12.8\\ \text {Investments } &9.4\\ \text { Intangibles } &6.8\\ \text {Property, plant, and equipment } &58.1\\ \text { Current liabilities } &6.4\\ \text { Long-term debt} &39.7\\ \text {Stockholders' equity } &40.8\end{array}$


Compute the debt to tangible net worth ratio.

A)146.8%
B)135.6%
C)53.0%
D)45.7%
E)none of the answers are correct

Question 14

A times interest earned ratio of 0.90 to 1 means:

A)that the firm will default on its interest payment.
B)that net income is less than the interest expense.
C)that the cash flow is less than the net income.
D)that the cash flow exceeds the net income.
E)none of the answers are correct.

Question 15

Which of the following statements is not correct?

A)A ratio that indicates a firm's long-term,debt-paying ability from the income statement view is the times interest earned.
B)Some of the items on the income statement that are excluded in order to compute times interest earned are interest expense,income taxes,and unusual or infrequent items.
C)Capitalized interest should be included with interest expense when computing times interest earned.
D)Usually,the highest times interest coverage in the most recent five-year period is used as the primary indication of the interest coverage.
E)In the short run,a firm can often meet its interest obligations,even when the times interest earned is less than 1.00.

Question 16

Which of these items represents a definite commitment to pay out funds in the future?

A)Bonds payable
B)Reserves for rebuilding furnaces
C)Deferred taxes
D)Noncontrolling shareholders' interests
E)Redeemable preferred stock

Question 17

In computing debt to tangible net worth,which of the following is not subtracted in the denominator?

A)Copyrights
B)Goodwill
C)Patents
D)Investments
E)Trademarks

Question 18

A fixed charge coverage:

A)is a balance sheet indication of debt carrying ability.
B)is an income statement indication of debt carrying ability.
C)is a liquidity ratio.
D)frequently includes research and development.
E)computation is standard from firm to firm.

Question 19

If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in the financial statements,then:

A)the times interest earned ratio will be overstated,based upon the financial statements.
B)the fixed charge ratio will be overstated,based upon the financial statements.
C)the debt ratio will be understated.
D)the working capital will be understated.
E)None of the answers are correct.

Question 20

Included in the Employee Retirement Income Security Act are the following:

A)provisions requiring minimum funding of pension plans.
B)minimum rights to employees upon termination of their employment.
C)creation of the Pension Benefit Guaranty Corporation.
D)provisions requiring minimum funding of pension plans and minimum rights to employees upon termination of their employment.
E)provisions requiring minimum funding of pension plans,minimum rights to employees upon termination of their employment,and creation of the Pension Benefit Guaranty Corporation.

Question 21

A number of assumptions about future events must be made regarding a defined benefit plan.Which of the following does not represent one of the assumptions?

A)Interest rates
B)Termination date for the firm
C)Employee turnover
D)Mortality rates
E)Compensation

Question 22

The balance sheet pension liability considers the projected benefit obligation.

Question 23

When analyzing a firm's long-term,debt-paying ability,we only want to determine the firm's ability to pay the principal.

Question 24

The debt to tangible net worth ratio is a more conservative ratio than the debt ratio.

Question 25

A defined benefit plan shifts the risk to the employee as to whether the pension funds will grow to provide for a reasonable pension payment upon retirement.

Question 26

Capitalized interest should not be considered as part of interest in the times interest earned computation.

Question 27

When a portion of operating lease payments is included in fixed charges,it is an effort to recognize the true total interest that the firm is paying.

Question 28

As with the debt ratio and the debt/equity ratio,from a long-term,debt-paying ability view,the lower the debt to tangible net worth ratio,the better.

Question 29

In general,the profitability of a firm is not considered to be important in determining the short-term,debt-paying ability of the firm.

Question 30

Under generally accepted accounting principles,an item must clearly represent a commitment to pay out funds in the future in order to be classified as a liability.

Question 31

A good times interest earned record would be indicated by a relatively high,stable coverage for the times interest earned coverage.

Question 32

Some companies achieve benefits by hundreds of millions of dollars by a pension termination.

Question 33

If an employee is in the pension plan,rights under this plan will be lost if the employee leaves the firm prior to receiving a vested interest.

Question 34

Noncontrolling shareholders' interest in earnings of subsidiaries are included in earnings for the times interest earned coverage.

Question 35

A joint venture can add significant potential liabilities to the parent company that are not on the face of the balance sheet.

Question 36

Equity earnings are excluded from earnings for the times interest earned coverage.

Question 37

When a firm is expensing an item faster on the tax return than on the financial statements,a deferred tax liability is the result.

Question 38

To get a better indication of a firm's ability to cover interest payments in the long run,the noncash charges for depreciation,depletion,and amortization can be added back to the times interest earned ratio.

Question 39

Which of the following statements is not true relating to a defined contribution pension plan?

A)A defined contribution plan defines the contributions of the company to the pension plan.
B)Once the defined contribution is paid,the company has no further obligation to the pension plan.
C)This type of plan shifts the risk to the employee as to whether the pension plan will grow to provide for a reasonable pension payment upon retirement.
D)There is no problem estimating the company's pension expense.
E)This type of plan presents substantial problems in estimating the pension liability.

Question 40

A potential significant liability is possible if the company withdraws from a multi-employer pension plan.

Question 41

Match the ratio that goes with each formula.

- $\frac {\text { Total Liabilities }} { \text {Shareholders' Equity - Intangible Assets} }$

A)times interest earned
B)fixed charge coverage
C)debt ratio
D)debt/equity ratio
E)debt to tangible net worth

Question 42

Amsterdam Antiques reported the following comparative income figures in 2012.
Your boss,the president of Amsterdam bank,is concerned about Amsterdam's borrowing capacity.A representative of Amsterdam Antiques feels that there should be no problem,since net income are the same with slightly higher sales.Required:
Compute times interest earned and comment on the bank's position.

Question 43

Repayment of a long-term bank loan would decrease the debt ratio.

Question 44

In the short run,a firm can often meet its interest obligations even when the times interest earned is less than 1.00.

Question 45

Match the ratio that goes with each formula.

- $\frac {\text {Recurring Earnings, Excluding Interest Expense, Tax Expense, Equity Earnings, and Noncontrolling Interest + Interest Portion of Rentals + Interest Portion of Rentals }} { \text {Interest Expense, including Capitalized Interest +Interest Portion of Rentals} }$

A)times interest earned
B)fixed charge coverage
C)debt ratio
D)debt/equity ratio
E)debt to tangible net worth

Question 46

Times interest earned indicates a firm's long-term,debt-paying ability from the balance sheet view.

Question 47

The tax expense for the financial statements often agrees with the taxes payable.

Question 48

Required:
Following is a list of paired ratios and transactions.For each transaction,indicate the effect of that transaction on the specific ratio.Use + for increase,- for decrease,and 0 for no effect.

Question 49

Some revenue and expense items never go on the tax return,but do go on the income statement.

Question 50

Match the ratio that goes with each formula.

- $\frac {\text { Recurring Earnings, Excluding Interest Expense, Tax Expense, Equity Earnings, and Noncontrolling Interest }} { \text {Interest Expense, Including Capitalized Interest} }$

A)times interest earned
B)fixed charge coverage
C)debt ratio
D)debt/equity ratio
E)debt to tangible net worth

Question 51

Mr.Jones has asked you to advise him of the long-term debt position of Dryden Corporation.He provides you with the ratios indicated below.
Required:
Give the implications and limitations of each item separately and then the collective inference one may draw about Dryden's long-term,debt-paying ability.

Question 52

Match the ratio that goes with each formula.

- $\frac {\text { Total Liabilities }} { \text {Shareholders' Equity} }$

A)times interest earned
B)fixed charge coverage
C)debt ratio
D)debt/equity ratio
E)debt to tangible net worth

Question 53

You have been asked to evaluate the long-term borrowing position of Client,Inc.However,you were given only the following limited information. $\begin{array}{lr}\text { Bonds payable, 12\% } & \$ 1,000,000 \\\text { Stockholders' equity } & 1,800,000 \\\text { Current assets } & 1,870,000 \\\text { Tangible assets, net } & 1,600,000 \\\text { Intangible assets } & 40,000 \\\text { Investments } & 120,000 \\\text { Other assets } & 90,000 \\\text { Sales } & 4,000,000 \\\text { Operating expenses } & 3,620,000\end{array}$

Required:
Assuming that this is the only information you will receive,estimate the following ratios:
a.Times interest earned ratio
b.Debt ratio
c.Debt/equity ratio
d.Debt to tangible net worth ratio

Question 54

Capitalization of interest results in interest being added to a fixed asset instead of expensed.

Question 55

Increases of profits by cutting the cost of sales would increase the times interest earned.

Question 56

Match the ratio that goes with each formula.

- $\frac {\text { Total Liabilities }} { \text {Total Assets} }$

A)times interest earned
B)fixed charge coverage
C)debt ratio
D)debt/equity ratio
E)debt to tangible net worth

Question 57

Aristocrats Art reported the following trend analysis to its bank as an attachment to a loan application.
You have been asked to evaluate the long-term borrowing capacity.You know that a rule of thumb for this industry for the debt/ equity ratio is 1 to 1.Required:
a.Compute the debt/equity ratio for 2012,2011,and 2010,using the debt ratio as a guide.
b.Comment on the long-term borrowing ability of this firm.