A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit margin of 6 percent. The firm's times interest earned ratio is:
A)16 times.
B)10 times.
C)7 times.
D)11 times.
E)20 times.

Question

Quizplus · Accepted Answer

First, we need to calculate the firm's earnings before interest and taxes (EBIT):
EBIT = Net Profit / Net Profit Margin
EBIT = 1,000,000 x 0.06 = $60,000

Then, we can use the formula for the times interest earned ratio:
Times Interest Earned Ratio = EBIT / Interest Charges

TIER = $60,000 / $10,000 = 6

Therefore, the firm's times interest earned ratio is 6 times. However, we need to adjust for taxes:
Adjusted TIER = (EBIT + Interest Charges x (1 - Tax Rate)) / Interest Charges

Adjusted TIER = ($60,000 + $10,000 x (1 - 0.4)) / $10,000 = 11

Therefore, the firm's adjusted times interest earned ratio is 11 times, which is choice (D).

A Firm Has Total Interest Charges of $10,000 Per Year