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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 RATIO AEI Incorporated has $5 billion in assets, and its tax rate is 40%. Its basic earning power (BEP) ratio is 10%, and its return on assets (ROA) is 5%. What is AEI’s times-interest-earned (TIE) ratio?

Summary Introduction

To identify: The times-interest earned ratio.

Return on Assets: It is a profitability ratio. This ratio shows profit earning capability on per dollar of assets. It shows the percentage of net income on total assets. Higher the returns on assets, the better will be the profitability. Total assets include fixed as well as current assets.

Times-Interest Earned Ratio: It is the type of solvency ratio, which indicates the capability of business to repay interest and provide debt related services. It shows the relation between earnings before interest and tax (EBIT) and long-term debt. It determines the debt servicing capacity of business keeping in view fixed interest on long-term debt.

Explanation

Solution:

Given,

EBIT is $550,000,000.

Interest expense is $133,333,334.

The formula to calculate times interest earned is,

Times Interest Earned=EBITInterest Expenses

Substitute $550,000,000 for EBIT and $133,333,334 in above formula.

Times Interest Earned=$550,000,000$133,333,334=4.12%

Thus, the times interest earned ratio is 4.12%.

Working notes:

Compute net income.

Given,

Net income is $5,000,000,000.

Return on assets is 5%.

The formula of return on asset (ROA) is,

ROA=Net IncomeTotal Value of Asset

Substitute $5,000,000,000 for total value of assets 5% for return on assets.

5%=Net Income$5,000,000,000Net Income=$5,000,000,000×5%Net Income=$250,000,000

Thus, net income is $250,000,000.

Compute earnings before tax.

Given,

Net income is $250,000,000.

Tax rate is 40%.

The formula to calculate earnings before tax is,

EBT=Net Income(1Tax Rate)

Substitute $250,000,000 for net income and 40% for tax rate

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