SOF Antiques (SOF) reported the following comparative income figures in 2006. Yo

Question

SOF Antiques (SOF) reported the following comparative income figures in 2006.

Your boss, the president of Alvarez Bank, is concerned about SOF's borrowing capacity. A representative of SOF feels that there should be no problem, since net profits are the same with slightly higher sales.

Required:

Compute times interest earned and comment on the bank's position.

2006 2005 Net Sales $701 $646 Other income 10 8 $711 $654 Costs and expenses: Cost of goods sold $472 $408 Selling and general expenses 176 156 Interest 28 22 $676 $586 Income before income taxes and extraordinary items $35 $68 Income taxes -15 -30 Income before extraordinary items $20 $38 Extraordinary items- fire $18 Net income $20 $20

Explanation / Answer

SOLUTION

Times Interest Earned = Recurring Earnings Before Interest, Tax, Minority Income and Equity Earnings / Interest Expense, Including Capitalized Interest

The ability of the firm to cover its interest has declined substantially due both to rising interest and falling income.

The statement by the SOF Antiques representative is false. The only reason that net income was at $20,000 in 2005 was because of the extraordinary fire loss. Recurring profits dropped from $38,000 to $20,000.

2006 2005 Income before income taxes and extraordinary items 35 68 Plus interest expense 28 22 Income (A) 63 90 Interest expense (B) 28 22 Times interest earned (A/B) 2.25 times 4.09 times

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