Download chapter 7—long-term debt

CHAPTER 7—LONG-TERM DEBT-PAYING ABILITY
MULTIPLE CHOICE
1. Jones Company has long-term debt of $1,000,000, while Smith Company, Jones' competitor, has longterm debt of $200,000. Which of the following statements best represents an analysis of the long-term
debt position of these two firms?
a. Smith Company's times interest earned should be lower than Jones.
b. Jones obviously has too much debt when compared to its competitor.
c. Jones should sell more stock and use less debt.
d. Smith has five times better long-term borrowing ability than Jones.
e. Not enough information to determine if any of the answers are correct.
ANS: E
2. Ingram Dog Kennels had the following financial statistics for 2010:
Long-term debt
(average rate of interest is 8%)
Interest expense
Net income
Income tax
Operating income
$400,000
35,000
48,000
46,000
107,000
What is the times interest earned for 2010?
a. 11.4 times
b. 3.3 times
c. 3.1 times
d. 3.7 times
e. none of the answers are correct
ANS: D
3. A times interest earned ratio of 0.90 to 1 means:
a. that the firm will default on its interest payment
b. that net income is less than the interest expense
c. that the cash flow is less than the net income
d. that the cash flow exceeds the net income
e. none of the answers are correct
ANS: B
4. Which of the following will not cause times interest earned to drop? Assume no other changes than
those listed.
a. An increase in bonds payable with no change in operating income.
b. An increase in interest rates.
c. A rise in preferred stock dividends.
d. A rise in cost of goods sold with no change in interest expense.
e. A drop in sales with no change in interest expense.
ANS: C
5. A times interest earned ratio indicates that:
a. preferred stock has no maturity date
b. the debt will never become due
c. the firm will be able to repay the principal when due
d. the principal can be refinanced
e. none of the answers are correct
ANS: E
6. Jordan Manufacturing reports the following capital structure:
Current liabilities
Long-term debt
Deferred income taxes
Preferred stock
Common stock
Premium on common stock
Retained earnings
$100,000
400,000
10,000
80,000
100,000
180,000
170,000
What is the debt ratio?
a. 0.48
b. 0.49
c. 0.93
d. 0.96
e. none of the answers are correct
ANS: B
7. The debt ratio indicates:
a. the ability of the firm to pay its current obligations
b. the efficiency of the use of total assets
c. the magnification of earnings caused by leverage
d. a comparison of liabilities with total assets
e. none of the answers are correct
ANS: D
8. Joseph and John, Inc., had the following balance sheet results for 2010:
(in millions)
Current liabilities
Bonds payable
Lease obligations
Minority interest
Common stock
Retained earnings
$12.6
18.6
2.7
1.4
8.6
22.9
$66.8
Compute the debt-equity ratio.
a. 112.1%
b. 87.6%
c. 67.6%
d. 46.7%
e. none of the answers are correct
ANS: A
9. Which of the following statements best compares long-term borrowing capacity ratios?
a. The debt/equity ratio is more conservative than the debt ratio.
b. The debt ratio is more conservative than the debt/equity ratio.
c. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
d. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
e. The debt ratio is more conservative than the debt to tangible net worth ratio.
ANS: D
10. In computing debt to tangible net worth, which of the following is not subtracted in the denominator?
a. Copyrights
b. Goodwill
c. Patents
d. Investments
e. Trademarks
ANS: D
11. A fixed charge coverage:
a. is a balance sheet indication of debt carrying ability
b. is an income statement indication of debt carrying ability
c. is a liquidity ratio
d. frequently includes research and development
e. computation is standard from firm to firm
ANS: B
12. The following financial statement data are taken from Xeron Company's 2010 annual report:
(in millions)
Current assets
Investments
Intangibles
Tangible assets (net)
Current liabilities
Long-term debt
Stockholders' equity
$12.6
9.4
6.8
58.1
6.4
39.7
40.8
Compute the debt ratio.
a. 196.9%
b. 113.0%
c. 53.0%
d. 45.7%
e. none of the answers are correct
ANS: C
13. The following financial statement data are taken from Xeron Company's 2010 annual report:
(in millions)
Current assets
Investments
Intangibles
Tangible assets (net)
Current liabilities
Long-term debt
Stockholders' equity
$12.6
9.4
6.8
58.1
6.4
39.7
40.8
Compute the debt to tangible net worth ratio.
a. 146.8%
b. 135.6%
c. 53.0%
d. 45.7%
e. none of the answers are correct
ANS: B
14. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in the
financial statements, then:
a. the times interest earned ratio will be overstated, based upon the financial statements
b. the fixed charge ratio will be overstated, based upon the financial statements
c. the debt ratio will be understated
d. the working capital will be understated
e. none of the answers are correct
ANS: C
15. Under the Employee Retirement Income Security Act, a company can be liable for its pension plan up
to:
a. 30 percent of its total assets
b. 30 percent of its net worth
c. 40 percent of its total assets
d. 40 percent of its net worth
e. 50 percent of its total assets
ANS: B
16. Included in the Employee Retirement Income Security Act are the following:
a. provisions requiring minimum funding of pension plans
b. minimum rights to employees upon termination of their employment
c. creation of the Pension Benefit Guaranty Corporation
d. provisions requiring minimum funding of pension plans and minimum rights to employees
upon termination of their employment
e. provisions requiring minimum funding of pension plans, minimum rights to employees
upon termination of their employment, and creation of the Pension Benefit Guaranty
Corporation
ANS: E
17. What significant improvement in the financial reporting of pensions have pension accounting rules
provided?
a. determination of the expense for the income statement
b. limited balance sheet recognition of pension liabilities
c. improved disclosure
d. determination of the expense for the income statement and limited balance sheet
recognition of pension liabilities
e. determination of the expense for the income statement, limited balance sheet recognition
of pension liabilities, and improved disclosure
ANS: E
18. There are a number of assumptions about future events that must be made regarding a defined benefit
plan. An assumption that does not need to be made is:
a. interest rates
b. employee turnover
c. mortality rates
d. compensation
e. how long the firm will continue
ANS: E
19. Which of the following statements is not correct?
a. A ratio that indicates a firm's long-term, debt-paying ability from the income statement
view is the times interest earned.
b. Some of the items on the income statement that are excluded in order to compute times
interest earned are interest expense, income taxes, and unusual or infrequent items.
c. Capitalized interest should be included with interest expense when computing times
interest earned.
d. Usually, the highest times interest coverage in the most recent five-year period is used as
the primary indication of the interest coverage.
e. In the short run, a firm can often meet its interest obligations, even when the times interest
earned is less than 1.00.
ANS: D
20. Which of these items represents a definite commitment to pay out funds in the future?
a. bonds payable
b. reserves for rebuilding furnaces
c. deferred taxes
d. minority shareholders' interests
e. redeemable preferred stock
ANS: A
21. Which of the following statements is not true relating to a capitalized (capital) lease?
a. A capital lease is handled as if the lessee bought the asset.
b. The leased asset is in the fixed assets and the related obligation is included in liabilities.
c. On the balance sheet, the capitalized asset amount will not usually agree with the
capitalized liability amount because the liability is reduced by payments, and the asset is
reduced by depreciation taken.
d. Usually, a company depreciates capitalized leases faster than payments are made.
e. On the balance sheet, the capitalized asset amount will usually be higher than the
capitalized liability amount.
ANS: E
22. Which of the following statements is not true relating to a defined contribution pension plan?
a. A defined contribution plan defines the contributions of the company to the pension plan.
b. Once the defined contribution is paid, the company has no further obligation to the
pension plan.
c. This type of plan shifts the risk to the employee as to whether the pension plan will grow
to provide for a reasonable pension payment upon retirement.
d. There is no problem estimating the company's pension expense.
e. This type of plan presents substantial problems in estimating the pension liability.
ANS: E
23. A number of assumptions about future events must be made regarding a defined benefit plan. Which of
the following does not represent one of the assumptions?
a. interest rates
b. termination date for the firm
c. employee turnover
d. mortality rates
e. compensation
ANS: B
TRUE/FALSE
1. When analyzing a firm's long-term, debt-paying ability, we only want to determine the firm's ability to
pay the principal.
ANS: F
2. In general, the profitability of a firm is not considered to be important in determining the short-term,
debt-paying ability of the firm.
ANS: T
3. A good times interest earned record would be indicated by a relatively high, stable coverage for the
times interest earned coverage.
ANS: T
4. Minority shareholders' interest in earnings of subsidiaries are included in earnings for the times interest
earned coverage.
ANS: T
5. Equity earnings are excluded from earnings for the times interest earned coverage.
ANS: T
6. Capitalized interest should not be considered as part of interest in the times interest earned
computation.
ANS: F
7. To get a better indication of a firm's ability to cover interest payments in the long run, the noncash
charges for depreciation, depletion, and amortization can be added back to the times interest earned
ratio.
ANS: F
8. When a portion of operating lease payments is included in fixed charges, it is an effort to recognize the
true total interest that the firm is paying.
ANS: T
9. Under generally accepted accounting principles, an item must clearly represent a commitment to pay
out funds in the future in order to be classified as a liability.
ANS: T
10. When a firm is expensing an item faster on the tax return than on the financial statements, a deferred
tax liability is the result.
ANS: T
11. As with the debt ratio and the debt/equity ratio, from a long-term, debt-paying ability view, the lower
the debt to tangible net worth ratio, the better.
ANS: T
12. The debt to tangible net worth ratio is a more conservative ratio than the debt ratio.
ANS: T
13. A joint venture can add significant potential liabilities to the parent company that are not on the face of
the balance sheet.
ANS: T
14. A potential significant liability is possible if the company withdraws from a multi-employer pension
plan.
ANS: T
15. A defined benefit plan shifts the risk to the employee as to whether the pension funds will grow to
provide for a reasonable pension payment upon retirement.
ANS: F
16. If an employee is in the pension plan, rights under this plan will be lost if the employee leaves the firm
prior to receiving a vested interest.
ANS: T
17. The balance sheet pension liability considers the projected benefit obligation.
ANS: F
18. Some companies achieve benefits by hundreds of millions of dollars by a pension termination.
ANS: T
19. Times interest earned indicates a firm's long-term, debt-paying ability from the balance sheet view.
ANS: F
20. Capitalization of interest results in interest being added to a fixed asset instead of expensed.
ANS: T
21. In the short run, a firm can often meet its interest obligations even when the times interest earned is
less than 1.00.
ANS: T
22. The tax expense for the financial statements often agrees with the taxes payable.
ANS: F
23. Some revenue and expense items never go on the tax return, but do go on the income statement.
ANS: T
24. Repayment of a long-term bank loan would decrease the debt ratio.
ANS: T
25. Increases of profits by cutting the cost of sales would increase the times interest earned.
ANS: T
PROBLEMS
1. Laura Bella Company reports the following statement of income:
Operating Revenues
$4,800
Costs and Expenses:
Cost of Sales
Selling, Service, Administrative, and General Expense
Income Before Interest Expense and Income Taxes
Interest Expense
Income Before Income Taxes
Income Taxes
Net Income
(2,000)
(1,500)
$1,300
(180)
$1,120
(350)
$ 770
Note: Depreciation expense totals $300; preferred dividends total $60; operating lease payments total
$180. Assume that 1/3 of operating lease payments is for interest.
Required:
a. Compute the times interest earned.
b. Compute the fixed charge coverage.
ANS:
a.
Times Interest Earned =
Recurring Earnings Before
Interest Expense, Tax,
Minority Income and Equity Earnings
Interest Expense, Including
Capitalized Interest
Income before income taxes
Plus interest
Adjusted income
Interest expense
(A) $1,300/(B) $180 = 7.22 times
$1,120
180
$1,300 (A)
$ 180 (B)
b.
Fixed Charge Coverage =
Recurring Earnings Before Interest
Expense, Tax, Minority Income
and Equity Earnings
+ Interest Portion of Rentals
Interest Expense, Including
Capitalized Interest + Interest
Portion of Rentals
Income before income taxes
Plus interest
Adjusted income
1/3 of operating lease payments
(1/3  $180)
$1,120
180
$1,300
Interest expense
1/3 of operating lease payments
$180
60
$240
Fixed charge coverage =
$1,360
$240
60
$1,360
= 5.67 times
2. The following information is computed from Fast Food Chain’s annual report for 2010.
2010
2009
Current assets
Property and equipment, net
Intangible assets, at cost
less applicable amortization
$ 2,731,020
10,960,286
$ 2,364,916
8,516,833
294,775
$13,986,081
255,919
$11,137,668
Current liabilities
Deferred federal income taxes
Mortgage note payable
Stockholders' equity
$ 3,168,123
160,000
456,000
10,201,958
$13,986,081
$ 2,210,735
26,000
—
8,900,933
$11,137,668
Net sales
Cost of goods sold
Selling and administrative expense
Interest expense
Income tax expense
Net income
$33,410,599 $25,804,285
(30,168,715) (23,159,745)
(2,000,000) (1,500,000)
(216,936)
(39,456)
(400,000)
(300,000)
$
624,948 $
805,084
Note:
One-third of the operating lease rental charge was $100,000 in 2010 and $50,000 in 2009.
Capitalized interest totaled $30,000 in 2010 and $20,000 in 2009.
Required:
a. Based on the above data for both years, compute:
1. times interest earned
2. fixed charge
3. debt ratio
4. debt/equity ratio
5. debt to tangible net worth
b. Comment on the firm's long-term borrowing ability based on the analysis.
ANS:
a.
1.
Recurring Earnings Before
Interest Expense, Tax, Minority
Income and Equity Earnings
Interest Expense, Including
Capitalized Interest
Times Interest Earned =
2010
33,410,599 $25,804,285
(30,168,715)
23,159,745)
(2,000,000)
(1,500,000)
$ 1,241,884
$ 1,144,540
$
Interest Expense
Capitalized Interest
Total Interest (B)
$
216,936
30,000
246,936
5.03 times
(A)/(B)
2. Fixed Charge Interest =
2009
$
Net Sales
Less Cost of Goods Sold
Selling and Administrative
(A)
$
39,456
20,000
59,456
$
19.25 times
Recurring Earnings Before
Interest Expense, Tax, Minority
Earnings, Equity Earnings, Plus
Interest Portion of Rentals
Interest Expense, Including
Capitalized Interest, Plus
Interest Portion of Rentals
2010
2009
From Part (1)
Interest Portion of Rentals
(A)
$1,241,884
100,000
$1,341,884
$1,144,540
50,000
$1,194,540
From Part (1)
Interest Portion of Rentals
(B)
$
$
$
3.87 times
(A)/(B)
3. Debt Ratio =
246,936
100,000
346,936
Total Liabilities
Total Assets
$3,784,123
$13,986,081
27.1%
$2,236,735
$11,137,668
20.1%
$
59,456
50,000
109,456
10.91 times
4. Debt/Equity Ratio =
Total Liabilities
Stockholders' Equity
$3,784,123
$10,201,958
$2,236,735
8,900,933
37.1%
5. Debt to Tangible Net Worth =
$3,784,123
$10,201,958 - $294,775
25.1%
Total Liabilities
Stockholders' Equity - Intangibles
= 38.2%
$2,236,735
$8,900,933 - $255,919
= 25.9%
b. In 2010, this firm had a substantial rise in debt. This included current liabilities, deferred
taxes, and a new mortgage note payable. This increased debt and the related increased interest
expense caused a decline in interest coverage and a rise in the debt, debt/equity, and debt to
tangible net worth ratios. In addition, operating lease rental charges went up, which lowered
the fixed charge coverage.
3. The following financial information is excerpted from the 2010 annual report of Retail Products, Inc.
Balance Sheet
(in thousands)
2010
2009
Current assets
Investments
Deferred charges
Property, plant, and equipment, net
Trademarks and leaseholds
Excess of cost over fair market
value of net assets acquired
Assets held for disposal
$
Total liabilities
Total stockholders' equity
449,195
32,822
4,905
350,921
45,031
$
433,049
55,072
12,769
403,128
47,004
272,146
276,639
6,062
$ 1,161,082
10,247
$1,237,908
$
689,535
471,547
$ 1,161,082
$
$ 2,020,526
(2,018,436)
(300,000)
(40,000)
$ (337,910)
$1,841,738
(1,787,126)
(250,000)
(30,000)
$ (225,388)
721,149
516,759
$1,237,908
Income Statement
Net sales
Cost of goods sold
Selling and administrative
Interest expense
Net income (loss)
Required:
For each year compute:
a. 1. Times interest earned
2. Debt ratio
3. Debt/equity ratio
4. Debt to tangible net worth ratio
b. Comment on the results.
c. Does a times interest earned ratio of less than 1 to 1 mean that the firm cannot pay its interest
expense?
ANS:
a.
Recurring Earnings Before
Interest, Tax, Minority Income
and Equity Earnings
Interest Expense, Including
Capitalized Interest
1. Times Interest Earned =
2010
$2,020,526 - $2,018,436 - $300,000
$40,000
Negative 7.45 Times
2009
$1,841,738 - $1,787,126 - $250,000
$30,000
Negative 6.51 Times
2. Debt Ratio =
Total Liabilities
Total Assets
2010
$689,535
$1,161,082
59.4%
3.
Debt/Equity Ratio =
2010
$689,535
$471,547
146.2%
2009
$721,149
$1,237,908
58.3%
Total Liabilities
Total Stockholders' Equity
2009
$721,149
$516,759
139.6%
4.
Debt to Tangible
Net worth Ratio
=
Total Liabilities
Total Stockholders' Equity - Intangible Assets
2010
$689,535
$471,547 - $45,031 - $272,146
= 446.7%
$721,149
$516,759 - $47,004 - $276,639
= 373.4%
2009
b. This firm has had a rise in the debt, debt/equity, and debt to tangible net worth ratios. The
debt to tangible net worth is especially high due to the high amount of excess of cost over fair
market value of net assets.
The times interest earned figure dropped from a negative 6.51 times in 2009 to a negative
7.45 times in 2010.
This firm's long-term borrowing ability appears to be very negative and deteriorated further
in 2010.
c. No, a times interest earned ratio of less than 1 to 1 does not mean, in the short run, that the
firm cannot meet its interest payments. Some of the expenses, such as depreciation, do not
require current funds, but they do reduce the interest coverage. Also, in the short run, the
outlay can come from sources of funds other than income.
4. Mr. Jones has asked you to advise him of the long-term debt position of Dryden Corporation. He
provides you with the ratios indicated below.
Fixed Charge Coverage
Times Interest Earned
Debt Ratio
Debt to Tangible Net Worth
2008
2009
2010
6.3
8.2
40%
80%
4.5
6.0
39%
81%
5.0
5.3
40%
84%
Required:
Give the implications and limitations of each item separately and then the collective inference one may
draw about Dryden's long-term, debt-paying ability.
ANS:
Times interest earned has declined. This can be caused by lower income, higher debt, or a combination
of both.
Fixed charge coverage has declined. The decline for this ratio has been less than the decline in the
times interest earned. This indicates that the use of noncapitalized leases has declined.
The debt ratio is relatively stable.
The debt to tangible net worth ratio has increased slightly. This can be caused by higher debt, lower
equity, or higher intangibles.
Since the debt ratio is relatively constant, the problem does
not appear to be higher debt. Rather, higher interest rates or lower income appear to be the problem.
Since the debt ratio is constant, the most logical explanation for the rise in debt to tangible net worth is
a rise in intangibles, which lowers the denominator.
The long-term debt position has declined, but we need more information about the company and
industry in order to come to a conclusion on the long-term debt position.
5. Amsterdam Antiques reported the following comparative income figures in 2010.
(in thousands)
2010 2009
Net sales
Other income
Costs and expenses:
Cost of goods sold
Selling and general expenses
Interest
Income before income taxes and extraordinary items
Income taxes
Income before extraordinary items
Extraordinary items—losses from fire
Net income
$701
10
$711
$646
8
$654
$472
176
28
$676
$ 35
(15)
$ 20
$408
156
22
$586
$ 68
(30)
$ 38
18
$ 20
$ 20
Your boss, the president of Amsterdam bank, is concerned about Amsterdam's borrowing capacity. A
representative of Amsterdam Antiques feels that there should be no problem, since net income are the
same with slightly higher sales.
Required:
Compute times interest earned and comment on the bank's position.
ANS:
Times Interest Earned =
Recurring Earnings Before
Interest, Tax, Minority
Income and Equity Earnings
Interest Expense, Including
Capitalized Interest
2010
2009
Income before income taxes and extraordinary items
Plus interest expense
(a)
$ 35
28
$ 63
$ 68
22
$ 90
(b) Interest expense
$ 28
$ 22
2.25 times
4.09 times
(a) ÷ (b)
The ability of the firm to cover its interest has declined substantially due both to rising interest and
falling income.
The statement by the Amsterdam Antiques representative is false. The only reason that net income was
at $20,000 in 2009 was because of the extraordinary fire loss. Recurring profits dropped from $38,000
to $20,000.
6. Required:
Following is a list of paired ratios and transactions. For each transaction, indicate the effect of that
transaction on the specific ratio. Use + for increase, - for decrease, and 0 for no effect.
Transaction
a. A firm is required to capitalize leases previously
presented only in notes.
b. A firm sells its own common stock.
c. A firm has an increase in selling expense with
no change in other expenses.
d. A firm writes off a sizeable account receivable.
e. A firm pays cash for a valuable patent.
ANS:
a.
b.
c.
d.
e.
+
0
+
Ratio
Debt Ratio of 0.4
Debt/Equity Ratio of 1.12
Times Interest Earned Ratio of 6.2 to 1
Times Interest Earned Ratio of 3.6 to 1
Debt to Tangible Net Worth Ratio of 1.3
to 1
7. Aristocrats Art reported the following trend analysis to its bank as an attachment to a loan application.
Fixed Charge Ratio
Times Interest Earned Ratio
Debt Ratio
Debt to Tangible Net Worth Ratio
2010
2009
2008
4.00
4.94
0.47
0.91
2.50
3.17
0.51
1.06
1.54
2.08
0.56
1.36
You have been asked to evaluate the long-term borrowing capacity. You know that a rule of thumb for
this industry for the debt/ equity ratio is 1 to 1.
Required:
a. Compute the debt/equity ratio for 2010, 2009, and 2008, using the debt ratio as a guide.
b. Comment on the long-term borrowing ability of this firm.
ANS:
a. If total liabilities are .47 of total assets, then total stockholders' equity must be .53, since total
liabilities plus total stockholders' equity = total assets.
Debt =
Equity
0.47
0.53
= .89 (2010)
0.51
0.49
= 1.04 (2009)
0.56
0.44
= 1.27 (2008)
b. This firm shows evidence of an improved, long-term borrowing capacity position. The times
interest earned ratio and the fixed charge ratio has improved, as has the debt ratio, debt to
tangible net worth ratio, and debt/equity ratio. The debt/equity ratio is now below the industry
average.
8. You have been asked to evaluate the long-term borrowing position of Client, Inc. However, you were
given only the following limited information.
$1,000,000
1,800,000
1,870,000
1,600,000
40,000
120,000
90,000
4,000,000
3,620,000
Bonds payable, 12%
Stockholders' equity
Current assets
Tangible assets, net
Intangible assets
Investments
Other assets
Sales
Operating expenses
Required:
Assuming that this is the only information you will receive, estimate the following ratios:
a. Times interest earned ratio
b. Debt ratio
c. Debt/equity ratio
d. Debt to tangible net worth ratio
ANS:
Computations for figures needed in the ratios follow.
Total assets:
$1,870,000
1,600,000
40,000
120,000
90,000
$3,720,000
Current assets
Tangible assets
Intangible assets
Investments
Other assets
Total assets
Liabilities:
$3,720,000
1,800,000
$1,920,000
Total assets
Less stockholders' equity
Total liabilities
Interest:
$1,000,000  0.12 = $120,000
a. Times Interest Earned Ratio
=
Recurring Earnings Before
Interest, Tax Minority Income
and Equity Earnings
Interest Expense, Including
Capitalized Interest
= $4,000,000 - $3,620,000 = 3.17
$120,000
times
b. Debt Ratio
=
=
c. Debt/Equity Ratio
=
=
d. Debt to Tangible
Net Worth Ratio
=
=
Total Liabilities
Total Assets
$1,920,000
$3,720,000
= 51.6%
Total Liabilities
Shareholder' Equity
$1,920,000
$1,800,000
= 106.7%
Total Liabilities
Shareholders' Equity - Intangible Assets
$1,920,000
= 109.1%
$1,800,000 - $40,000
9. Required:
Indicate the effect of each of the following transactions on the ratios listed. Use + to indicate an
increase, - to indicate a decrease, and 0 to indicate no effect. Assume an initial times interest earned
ratio of 3 to 1, debt ratio of 0.5 to 1, debt/equity ratio of 1.0 to 1, and total debt to tangible net worth
ratio of 1.1 to 1.
Transaction
a. Collection of accounts receivable.
b. Firm has decreasing profits due to rising cost of
sales.
c. Firm appropriates a substantial amount for
expansion.
d. Conversion of preferred stock to common.
e. Repayment of a short-term bank loan (ignore
interest).
f. Payment for a valuable trademark.
g. The stock is split two for one.
h. Purchase of equipment financed by a long-term
note (consider interest).
i. Conversion of bonds to stock.
j. Declaration and payment of dividend.
k. The firm experiences a rise in the rate charged
on its line of credit.
Times
Interest
Debt
Earned Ratio Ratio
Debt
Total Debt
Equity Tangible Net
Ratio Worth Ratio
ANS:
Transaction
a. Collection of accounts receivable.
b. Firm has decreasing profits due to rising cost of
sales.
c. Firm appropriates a substantial amount for
expansion.
d. Conversion of preferred stock to common.
e. Repayment of a short-term bank loan (ignore
interest).
f. Payment for a valuable trademark.
g. The stock is split two for one.
h. Purchase of equipment financed by a long-term
note (consider interest).
i. Conversion of bonds to stock.
j. Declaration and payment of dividend.
k. The firm experiences a rise in the rate charged
on its line of credit.
Times
Interest
Debt
Earned Ratio Ratio
Debt
Total Debt
Equity Tangible Net
Ratio Worth Ratio
0
-
0
-
0
-
0
-
0
0
0
0
0
0
0
-
0
-
0
-
0
0
-
0
0
+
0
0
+
+
0
+
+
0
-
+
+
+
+
+
+
10. Listed below are several ratios.
a.
b.
c.
d.
e.
times interest earned
fixed charge coverage
debt ratio
debt/equity ratio
debt to tangible net worth
Required:
Match the letter that goes with each formula.
_____ 1.
_____ 2.
Total Liabilities
Shareholders' Equity - Intangible Assets
Total Liabilities
Total Assets
_____ 3.
Recurring Earnings, Excluding
Interest Expense, Tax Expense,
Equity Earnings, and Minority Expense
Interest Expense, Including
Capitalized Interest
_____ 4.
Recurring Earnings, Excluding
Interest Expense, Tax Expense,
Equity Earnings, and Minority Earnings
+ Interest Portion of Rentals
Interest Expense, including
Capitalized Interest + Interest
Portion of Rentals
_____ 5.
ANS:
1.
2.
3.
4.
5.
e
c
a
b
d
Total Liabilities
Shareholders' Equity