This year, Ferro Inc. generated sales of $10 million. Its fixed operating cost is $1 million and its variable cost ratio is 30 percent of sales. Ferro has $60 million of debt outstanding with a before-tax cost of 12 percent. Which of the following statements about Ferro's times interest earned (TIE) ratio is correct?

Question

Quizplus · Accepted Answer

First, we need to calculate Ferro's earnings before interest and taxes (EBIT).
Total Variable costs = 0.3 x $10 million = $3 million
EBIT = Sales - Variable costs - Fixed cost = $10 million - $3 million - $1 million = $6 million

Next, we can calculate Ferro's TIE ratio.
TIE = EBIT/Interest expense
Interest expense = Before-tax cost of debt x Debt outstanding = 0.12 x $60 million = $7.2 million
TIE = $6 million/$7.2 million = 0.83

Therefore, the correct choice is B. Ferro's TIE ratio is 0.83, which suggests it does not have enough earnings to meet the required interest payments.

This Year, Ferro Inc