7-4 Debt Management Ratios Problem 7-10 Times-Interest-Earned Ratio The Morris Corporation has $900,000 of debt outstanding, and it pays an interest rate of 10% annually

Finance Dec 24, 2020

7-4 Debt Management Ratios

Problem 7-10 Times-Interest-Earned Ratio

The Morris Corporation has $900,000 of debt outstanding, and it pays an interest rate of 10% annually. Morris's annual sales are $4.5 million, its average tax rate is 40%, and its net profit margin on sales is 4%. If the company does not maintain a TIE ratio of at least 5 to 1, then its bank will refuse to renew the loan and bankruptcy will result. What is Morris's TIE ratio? Round intermediate calculations to two decimal places. Round your answer to two decimal places.

Expert Solution

The TIE ratio is computed as follows:

= [ [ (Annual sales x Net profit margin) / (1 - tax rate) ] + (Amount of debt x interest rate) ] / (Amount of debt x interest rate)

= [ [ ($ 4,500,000 x 4%) / 0.60 ] + ($ 900,000 x 10%) ] / ($ 900,000 x 10%)

= ($ 300,000 + $ 90,000) / $ 90,000

= $ 390,000 / $ 90,000

= 4.33

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