Calculate the times interest earned ratio using the following information. Sales = $1.5 million, cost of goods sold = $800,000, depreciation expense = $100,000, addition to retained earnings = $85,000, dividends per share = $1.2, tax rate = 30 percent, and number of shares of common stock outstanding = 100,000. Assume the firm has no preferred stock.
A) 2.25 times
B) 1.25 times
C) 1.95 times
D) 2.75 times

Question

Quizplus · Accepted Answer

To calculate the Times Interest Earned (TIE) ratio, we first need to find the Earnings Before Interest and Taxes (EBIT). Starting with sales, subtract the cost of goods sold and depreciation to find EBIT:EBIT = Sales - Cost of Goods Sold - Depreciation Expense    = $1,500,000 - $800,000 - $100,000    = $600,000Next, we calculate the net income to find the interest expense. Net income is found by subtracting taxes and adding back to retained earnings (since dividends are not a factor in calculating EBIT):Net Income = (EBIT - Interest Expense) * (1 - Tax Rate) + Interest ExpenseGiven that addition to retained earnings is $85,000 and dividends are $1.2 per share for 100,000 shares (total dividends = $120,000), the total earnings available to shareholders is $205,000.To find the net income before adding interest (since we don't have it directly), we reverse the net income formula:$205,000 = (EBIT - Interest Expense) * (1 - 0.30) + Interest ExpenseSolving for Interest Expense directly is complex without the explicit net income before taxes, but we aim to find the TIE ratio, which is EBIT/Interest Expense. Given the choices provided and the calculation process, the correct answer involves understanding the relationship between EBIT, net income, and the interest expense, which is not directly calculable with the provided information. However, the correct approach to find the TIE ratio typically involves calculating EBIT (done) and then using the interest expense to find the ratio. The mistake here is in the explanation process, as the direct calculation of net income and then backing out interest expense is not straightforward without additional information. The correct TIE ratio calculation directly involves EBIT and interest expense, but given the data, we cannot accurately calculate interest expense or net income without knowing either the interest expense directly or having a clearer path to back-calculate it from net income. Therefore, the selection of the correct answer (C) is based on an understanding of the TIE ratio concept but the explanation provided does not accurately reflect a direct path to calculate it with the given information.

Calculate the Times Interest Earned Ratio Using the Following Information