A Toronto ﬁrm has a times interest earned ratio of 2.7 times. This means:
A) The ﬁrm generated enough cash to cover its interest expense 2.7 times.
B) The ﬁrm has suﬃcient EBIT to cover its interest expense 2.7 times.
C) The interest expense of this ﬁrm exceeded earnings before taxes by 2.7 times.
D) The net income of this ﬁrm is suﬃcient to cover its interest expense 2.7 times.
E) The ﬁrm earned $1 in EBIT for every $2.70 it paid out in interest.

Question

Quizplus · Accepted Answer

The times interest earned ratio is a measure of a company's ability to cover its interest expense with its earnings before interest and taxes (EBIT). A times interest earned ratio of 2.7 times means that the firm has sufficient EBIT to cover its interest expense 2.7 times. Option A is incorrect because generating enough cash to cover interest expense is not the same as having sufficient EBIT to cover interest expense. Option C is incorrect because it implies that the interest expense exceeds the earnings, which is not the case. Option D is incorrect because it only mentions net income, which does not take into account interest expense. Option E is incorrect because it implies that the firm paid out $2.70 in interest for every $1 in EBIT, which is the opposite of the correct interpretation of the times interest earned ratio.

A Toronto ﬁRm Has a Times Interest Earned Ratio of 2.7