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Homework answers / question archive / The HR Pickett corporation has $500,000 of debt outstanding, and pays an interest rate of 10% annually, Pickett's annual sales are $2 millions, it's average tax rate is 30% , and it's net profit margin on sales 5%

The HR Pickett corporation has $500,000 of debt outstanding, and pays an interest rate of 10% annually, Pickett's annual sales are $2 millions, it's average tax rate is 30% , and it's net profit margin on sales 5%

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The HR Pickett corporation has $500,000 of debt outstanding, and pays an interest rate of 10% annually, Pickett's annual sales are $2 millions, it's average tax rate is 30% , and it's net profit margin on sales 5%. If the company does not maintain a TIE ratio of at least 5 times, it's Bank's will refuse to renew the loans, and bankruptcy will result:
What is Pickett's TIE ratio?

Question #2
Certain liability and net worth item generally increase spontaneously with increase in sales. Put a check by those items that typically increase spontaneously:

Account Payable__________ Notes Payable to banks__________________

Accrued wages____________ Mortgage bonds___________________

Common Stocks___________ Retained Earnings___________________

Question #3
The following equation can, under certain assumptions, be used to forecast financial requirements:

AFN = (A* / So) (AS) - MS1 (RR).

Under what conditions does the equation give satisfactory predictions and when should it not be used?.

pur-new-sol

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Problem #1.
TIE ratio can be computed as Profit before Interest and Taxes/Total Interest Charges. Now, total Interest Charges are 10% of $500,000 of debt which is $50,000.
Net profit margin means the ratio of Profit after taxes (P) to the annual revenue (sales). So we would have:
0.05 = P/Sales => P = 0.05*Sales.
Now Profit after taxes is Profit before Interest and Taxes (Pb) - Interest - Taxes, i.e.
P = Pb - Interest - Taxes = Pb - Interest - 0.3*Pb (tax rate = 30%) = 0.7*Pb - Interest.
Combining those two, we get:
0.05*Sales = 0.7*Pb - Interest. So Pb = (0.05*Sales + Interest)/0.7 = $71,428.57 (Sales = $2M, Interest = $50,000)
Therefore the TIE ratio is Pb/Interest = 1.43.

Question#2
Those would be Common Stocks and Retained Earnings.

Question#3
It shouldn't be used when So is close to zero as it would make the computations questionable.

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