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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

TIE AND ROIC RATIOS The H.R. Pickett Corp. has $500,000 of interest-bearing debt out-standing, and it pays an annual interest rate of 10%. In addition, it has $700,000 of common stock on its balance sheet. It finances with only debt and common equity, so it has no preferred stock. Its annual sales are $2 million, its average tax rate is 30%, and its profit margin is 5%. What are its TIE ratio and its return on invested capital (ROIC)?

Summary Introduction

To determine: Times-interest-earned (TIE) ratio and return on invested capital (ROIC).

Times-Interest-Earned (TIE) Ratio: It represents the firm’s capacity to pay its interest expenses. It is calculated by dividing earnings before interest and tax to interest expense.

Return on Invested Capital (ROIC): It represents the amount of return earned by all the investors; it can be calculated by dividing earnings available for investors to total invested capital.

Explanation

Solution:

Given,

Debt is $500,000.

Interest on debt is 10%.

Common stock is $700,000.

Sales are $2 million.

Average tax rate is 30%.

Profit margin is 5%.

Calculated values,

Earnings before interest and tax are $192,857.14.

Interest expenses are $50,000.

Formula to calculate times-interest-earned (TIE) ratio,

Times-interest-earned (TIE) ratio=EarningbeforeinterestandtaxInterestexpenses

Substitute $192,857.14 for earnings before interest and tax and $50,000 for interest expenses.

Times-interest-earned (TIE) ratio=$192,857.14$50,000=3.86×

Here, time-interest-earned ratio is 3.86×.

Formula to calculate return on invested capital,

Return on Invested Capital=Earning BeforeInterestandTax×(1Tax)Debt+CommonEquity

Substitute $192,857.14 for earnings before interest and tax, 0.3 for tax, $500,000 for debt and $700,000 for common equity.

Return on Invested Capital=$192,857.14×(10.3)$500,000+$700,000=$192,857

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