Chapter 7 Long term Debt Paying Ability Solutions

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 .

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that the cash flow is less than the net income c . 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

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5.

A times interest earned ratio indicates that: a . b . c . d . e .

preferred stock has no maturity date the debt will never become due the firm will be able to repay the principal when due the principal can be refinanced 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 .

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ANS: D

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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

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.

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

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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

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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

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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 .

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employee turnover b . c mortality rates . d compensation . e how long the firm will continue .

ANS: E

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19. a . b . c . d . e .

Which of the following statements is not correct? A ratio that indicates a firm's long-term, debt-paying ability from the income statement view is the times interest earned. 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. Capitalized interest should be included with interest expense when computing times interest earned. Usually, the highest times interest coverage in the most recent five-year period is used as the primary indication of the interest coverage. 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. .

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This type of plan presents substantial problems in e 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

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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

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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

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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

$1,120

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Plus interest Adjusted income Interest expense

180 $1,300 (A) $ 180 (B)

(A) $1,300/(B) $180 = 7.22 times 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

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2.

The following information is computed from Fast Food Chain’s annual report for 2010. 2010 Current assets Property and equipment, net Intangible assets, at cost less applicable amortization

Current liabilities Deferred federal income taxes Mortgage note payable Stockholders' equity

Net sales Cost of goods sold Selling and administrative expense Interest expense Income tax expense Net income

Note:

$ 2,731,02 0 10,960,286 294,77 5 $13,986,08 1 $ 3,168,12 3 160,000 456,000 10,201,95 8 $13,986,08 1 $33,410,59 9 (30,168,71 5) (2,000,000 ) (216,936) (400,00 0) $ 624,94 8

2009 $ 2,364,916 8,516,833 255,91 9 $11,137,668 $ 2,210,735 26,000 — 8,900,93 3 $11,137,668 $25,804,285 (23,159,745 ) (1,500,000) (39,456) (300,000 ) $

805,084

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.

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ANS: a. 1.

Times Interest Earned =

Recurring Earnings Before Interest Expense, Tax, Minority Income and Equity Earnings Interest Expense, Including Capitalized Interest 201

2009

0 Net Sales Less Cost of Goods Sold Selling and Administrative (A)

$ 33,410,599 (30,168,71 5) (2,000,0 00) $

1,241,884

Interest Expense Capitalized Interest Total Interest (B) (A)/(B)

2 Fixed Charge Interest =

$ 216,936 30,00 0 $ 246,936 5.03 times

$25,80 4,285 23,15 9,745) (1,50 0,000) $ 1,144, 540 $ 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

From Part (1) Interest Portion of Rentals

2010

2009

$1,241 ,884 10 0,000

$1,144 ,540 50 ,000

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(A)

$1,341 ,884

From Part (1)

$ 246,93 6 100 ,000

Interest Portion of Rentals (B)

$ 346 ,936

( A )/ ( B ) 3.

3

.87 times

Debt Ratio =

$1,194 ,540 $ 59,456 50 ,000 $ 109,4 56 10.91 times

Total Liabilities Total Assets $3,784,123 $13,986,081 27.1%

$2,236,735 $11,137,668 20.1%

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Total Liabilities

4. Debt/Equity Ratio =

Stockholders' Equity $3,784,123 $10,201,958 37.1% 5. Debt to Tangible Net Worth =

$2,236,735 8,900,933 25.1%

Total Liabilities Stockholders' Equity - Intangibles

$3,784,123 $10,201,958 - $294,775

b .

= 38.2%

$2,236,735 $8,900,933 - $255,919

= 25.9%

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

$ 449,195 32,822 4,905 350,921 45,031

433,049 55,072 12,769 403,128 47,004

$

272,146 6,06 2 $ 1,161,082

276,639 10,2 47 $1,237,908

$

Total liabilities

689,535

Total stockholders' equity 471,547 $ 1,161,082

$ 721,149 516,75 9 $1,237,908

Income Statement Net sales Cost of goods sold

$ 2,020,526 (2,018,436)

$1,841,738 (1,787,126 )

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Selling and administrative Interest expense

(300,000) (40,000 ) $ (337,910 )

Net income (loss)

(250,000) (30,000 ) $ (225,388 )

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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 . 1 .

Recurring Earnings Before Interest, Tax, Minority Income and Equity Earnings

Times Interest Earned =

Interest Expense, Including Capitalized Interest 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 $1,161,08 2 59.4%

3 Debt/Equ ity Ratio =

2009 $721,149 $1,237,90 8 58.3%

Total Liabilities Total Stockholders'

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Equity 2010 $689,535 $471,547 146.2%

2009 $721,14 9 $516,75 9 139.6%

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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.

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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

$646

10 $711

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.

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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. a . b . c . d . e .

Transaction A firm is required to capitalize leases previously presented only in notes. A firm sells its own common stock.

Ratio Debt Ratio of 0.4 Debt/Equity Ratio of 1.12

A firm has an increase in selling expense with no change in other expenses. A firm writes off a sizeable account receivable. A firm pays cash for a valuable patent.

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

ANS: a . b . c

+ -

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. d . e .

0 +

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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

b .

0.47 0.53

= .89 (2010)

0.51 0.49

= 1.04 (2009)

0.56 0.44

= 1.27 (2008)

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.

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8.

You have been asked to evaluate the long-term borrowing position of Client, Inc. However, you were given only the following limited information. Bonds payable, 12% Stockholders' equity Current assets Tangible assets, net Intangible assets Investments Other assets Sales Operating expenses

$1,000,000 1,800,000 1,870,000 1,600,000 40,000 120,000 90,000 4,000,000 3,620,000

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: Current assets Tangible assets Intangible assets Investments Other assets Total assets

$1,870,000 1,600,000 40,000 120,000 90,000 $3,720,000

Liabilities: Total assets Less stockholders' equity Total liabilities

$3,720,000 1,800,000 $1,920,000

Interest: $1,000,000 × 0.12 = $120,000

a

Times Interest Earned

=

Recurring Earnings Before Interest, Tax Minority Income and Equity Earnings

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.

Ratio Interest Expense, Including Capitalized Interest

b .

Debt Ratio

=

$4,000,000 $3,620,000 $120,000

= 3.17 time s

=

Total Liabilities Total Assets

=

c .

Debt/Equity Ratio

=

$1,920,000 $3,720,000

= 51.6%

Total Liabilities Shareholder' Equity

=

$1,920,000

= 106.7%

$1,800,000

d Debt to Tangible . Net Worth Ratio

=

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

Times Interest

Debt

Debt Equity

Earned

Ratio

Ratio

Total Debt Tangible Net Worth

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Ratio a . b . c . d . e . f. g . h . i. j. k .

Ratio

Collection of accounts receivable. Firm has decreasing profits due to rising cost of sales. Firm appropriates a substantial amount for expansion. Conversion of preferred stock to common. Repayment of a short-term bank loan (ignore interest). Payment for a valuable trademark. The stock is split two for one. Purchase of equipment financed by a longterm note (consider interest). Conversion of bonds to stock. Declaration and payment of dividend. The firm experiences a rise in the rate charged on its line of credit.

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ANS: Times Interest

Debt

Debt Equity

Earned Ratio

Ratio

Ratio

Collection of accounts receivable.

0

0

0

0

Firm has decreasing profits due to rising cost of sales. Firm appropriates a substantial amount for expansion. Conversion of preferred stock to common.

-

-

-

-

0

0

0

0

0

0

0

0

Repayment of a short-term bank loan (ignore interest). Payment for a valuable trademark. The stock is split two for one.

0

-

-

-

0 0

0 0

0 0

+ 0

Purchase of equipment financed by a longterm note (consider interest). Conversion of bonds to stock. Declaration and payment of dividend. The firm experiences a rise in the rate charged on its line of credit.

-

+

+

+

+ 0 -

+ +

+ +

+ +

Transaction a . b . c . d . e . f. g . h . i. j. k .

Total Debt Tangible Net Worth Ratio

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10. a. b. c. d. e.

Listed below are several ratios.

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.

Total Liabilities Shareholders' Equity Intangible Assets

_____ 2.

Total Liabilities Total Assets Recurring Earnings, Excluding Interest Expense, Tax Expense, Equity Earnings, and Minority Expense

___ __ 3.

Interest Expense, Including Capitalized Interest Recurring Earnings, Excluding Interest Expense, Tax Expense, Equity Earnings, and Minority Earnings + Interest Portion of Rentals

___ __ 4.

Interest Expense, including Capitalized Interest + Interest Portion of Rentals _____ 5.

Total Liabilities Shareholders' Equity

ANS: 1 .

e

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2 . 3 . 4 . 5 .

c a b d

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