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Times-Interest-Earned Ratio The Morris Corporation has $600,000 of debt outstanding, and it pays an interest rate of 10% annually
Times-Interest-Earned Ratio
The Morris Corporation has $600,000 of debt outstanding, and it pays an interest rate of 10% annually. Morris's annual sales are $3 million, its average tax rate is 35%, and its net profit margin on sales is 4%. If the company does not maintain a TIE ratio of at least 4 to 1, its bank will refuse to renew the loan and bankruptcy will result. What is Morris's TIE ratio? Do not round intermediate calculations. Round your answer to two decimal places.
Expert Solution
Computation of Morris's TIE Ratio:
TIE Ratio = EBIT / Interest
Here,
Profit Margin = Net Income / Sales
4% = Net Income / $3 million
Net Income = $3 million * 4% = $120,000
Net income before tax = Net Income/(1-tax rate)
= $120,000/(1-35%)
Net income before tax =$184,615.38
Earning before Interest & Tax = Net income before tax + Interest Expenses
= $184,615.38 + ($600,000*10%)
= $184,615.38 + $60,000
Earning before interest & tax = $244,615.38
TIE Ratio = $244,615.38/$60,000 = 4.8 times
As TIE ratio is 4.8 times bank will not refuse to renew the loan and bankruptcy will not result.
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