To explain: The impact on interest coverage due to the dramatic expansion of corporate debt.
Introduction:
Corporate Debt:
It is the debt owed by corporations rather than governments or individuals. It is circulated as commercial paper while long-term debt is circulated as bonds. It is a non-government debt security.
Interest coverage ratio:
It is a financial ratio used to determine the way a corporation can timely and easily pay interest on its debt.
Answer to Problem 1DQ
The impact on interest coverage due to the dramatic expansion of corporate debt was such that the ratio had been brought down to almost less than half the original interest.
Explanation of Solution
Over the years, precisely since 1977, it has been observed by many analysts that there is a dramatic expansion of corporate debt over the last 3 decades. It has a major impact on interest coverage as U.S. manufacturing corporations had to cover their interest 8 times. Not only that, the value of the ratio was brought down to less than half the original value by the 2000s.
Want to see more full solutions like this?
Chapter 16 Solutions
FOUNDATIONS OF FINANCIAL MANAGEMENT COD
- At the beginning of 2018, corporate tax rates decreased from 35% to 21%. Did this decrease in tax rates increase or decrease the advantage of financing with debt?arrow_forwardWhat is the dollar cost of this debt to Flatiron Group if, instead, the pound appreciates from $2.0625/£ to $2.1640/£ over the year? Please enter your answer as % -- e.g. if your answer is 2.34% type in 2.34.arrow_forwardA firm paid interest of $60 this year. Last year, they had $400 in debt. This year, they had $800 in debt. What was their CF to creditors? Hint: CF to creditors = interest paid - net borrowing Net borrowing = debt this year - debt last yeararrow_forward
- Examine the following income statement: Approximately how much does the outstanding debt cost shareholders every year? a. $50 b. $33 c. $88arrow_forwardThe Golden Gate Bridge in San Francisco was financed with construction bonds sold for $35 million in 1931. These were 40-year bonds, and the $35 million principal plus almost $39 million in interest were repaid in total in 1971. If interest was repaid as a lump sum, what interest rate was paid on the construction bonds?arrow_forwardIt is the policy of the corporation to maintain current ratio of 1.5 to 1.0. Its current liabilities are 400,000 and present current ratio is 2 to 1. How much is the maximum level of new short term loans it can secure without violating the policy? a• 400,000 b• 533,333 c• 200,000 d• 300,000arrow_forward
- What was the average annual rate of return on 3-month U.S. Treasury bills during the period 1990 to 2014? Select one: O a. 2.15% O b. 4.23% O c. 5.68% O d. 3.04%arrow_forwardReed plc is considering how to improve its debtor collection policy. The following information is available. Current Credit Sales: £912,000 Average debtor collection period (days): 94 days Wishing to introduce a new policy of payment within (days): 60 days Anticipated reduction in sales per year: £40,000 Increased collection costs per yer: £2,000 Short-term cost of borrowing (%): 30% Sales contribution to profit: 20% Required What will be the net benefit if Reed successfully enforces the new policy? When a corporation raises finance, there are two options: long-term debt finance (bank loan or corporate bonds) and equity finance (ordinary shares). The two approaches have fundamental consequences to the corporation. What are the main differences between the two approaches?arrow_forwardConsider the following information for a period of years: Arithmetic Mean Long-term government bonds 7.0 % Long-term corporate bonds 7.1 Inflation 4.0 What is the real return on long-term government bonds? ____%arrow_forward
- ABC Co. paid out one-half of its 1994 earnings by dividends. Its earnings increased by 20% and the amounts of its dividends increased by 15% in 1995. ABC's dividend payout ratio for 1995 was? ABC Company's bonds have a provision which stipulates that the ratio of senior debt to total assets will never rise above 45%. The company is at the limit of that ratio and it wishes to issue still another $25 million in senior debt. How much additional equity capital must it raise to comply with this restrictive provision? A. 55.56 Million B. 30.56 Million C. 20.45 Million D. 11.25 Million ABC has annual sales of $365 million. The company's days sales outstanding (calculated on a 365-day basis) is 50, which is well above the industry average of 35. The company has $200 million in current assets, $150 million in current liabilities, and $75 million in inventories. The company's goal is to reduce its DO to the industry average without reducing sales. Cash freed up would be used to repurchase…arrow_forwardIn the fall of 2008, AIG, the largest insurance companyin the world at the time, was at risk of defaulting due tothe severity of the global financial crisis. As a result, theU.S. government stepped in to support AIG with largecapital injections and an ownership stake. How wouldthis affect, if at all, the yield and risk premium on AIGcorporate debt?arrow_forwardICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 9 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.6 percent annually. What is the company's pretax cost of debt? If the tax rate is 24 percent, what is the aftertax cost of debt? Pretax cost of debt: __________% Aftertax cost of debt: __________%arrow_forward
- Intermediate Accounting: Reporting And AnalysisAccountingISBN:9781337788281Author:James M. Wahlen, Jefferson P. Jones, Donald PagachPublisher:Cengage LearningBusiness/Professional Ethics Directors/Executives...AccountingISBN:9781337485913Author:BROOKSPublisher:Cengage