Chapter 4, Problem 13P

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

TIE AND ROIC RATIOS The W.C. Pruett Corp. has $600,000 of interest-bearing debt outstanding, and it pays an annual interest rate of 7%. In addition, it has$600,000 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 $2.7 million, its average tax rate is 35%, and its profit margin is 7%. 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 the 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 the earnings available for investors to total invested capital. Explanation Given, Debt is$600,000.

Interest on debt is 7%.

Common stock is $600,000. Sales are$2.7 million.

Average tax rate is 35%.

Profit margin is 7%.

Calculated values,

Earnings before interest and tax are $332,769.23. Interest expenses are$42,000.

Times-interest-earned ratio

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

Times-interest-earnedĀ (TIE)Ā ratio=EarningābeforeāinterestāandātaxInterestāexpenses

Substitute $332,769.23 for earnings before interest and tax and$42,000 for interest expenses.

Times-interest-earnedĀ (TIE)Ā ratio=$332,769.23$42,000=7.92Ć

Here, time-interest-earned ratio is 7.92Ć .

Return on invested capital

Formula to calculate return on invested capital,

ReturnĀ onĀ investedĀ capital=EarningĀ beforeāinterestāandātaxĆ(1āTax)Debt+Commonāequity

Substitute $332,769.23 for earnings before interest and tax, 0.35 for tax,$600,000 for debt and $600,000 for common equity. ReturnĀ onĀ InvestedĀ Capital=$332,769.23Ć(1ā0.35)$600,000+$600,000=\$332,769

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