0.52 polnts C10-1 Calculating Interest and Depreciation Expenses and Effects on

Question

0.52 polnts C10-1 Calculating Interest and Depreciation Expenses and Effects on Loan Covenant Ratios (Chapters 9 and 10) ?9-3, LO 9-7, LO 10-2, LO 10-5] Zoom Car Corporation (ZCC) plans to purchase approxlimately 100 venicles on December 31, 2015, for $3.0 million, plus 8 percent botal sales tax. Zcc expects to use the vehicles for 5 years and then sell them for approxlmately $540,000. ZCC anticlpates the tollowing average vehicle use over each year ended December 31 2018 17500 2019 17500 2020 5.000 2016 Miles per year 5000 2017 To tinance the purchase, ZCC signed a 5-jear promissory note on December 31, 2015, for $2 70 million, w Intereet paid annualy at the market Interest rate of 6 percent. The note carrles loan covenants that require zcc to maintain a minlmum times Interest eanned ratio of3.0 anda minimum wed aseet turnover ratio of 1.0. cC orecasts that the company will generate the followling sales and prellminary eanings (prior to recording depreclation on the vehnicles and Interest on tne note). (For purposes of thls question, ignore Income tax) (in 0005) Sales Revenue ncome before Depreclation and interest Expense 2016 2017 2018 2019 2020 5 3,000 3,500 3800 3900 4,000 1500 1.700 90 2000 2100 Required: 1. Calculate the amount of interest expense that would be recorded each year. Answer is complete and correct. 162000 per 2. calculate the depreciation expense that would be recorded ea? year, using te followhg deprecation (a) Straight-line (b) Double-declining-balance(Do not round Intermedlate calculations] 2016 2017 2018 2019 2016 2017 2018 2019

Explanation / Answer

Note: There are more than 4 parts of this question, so as per rule I am answering first 4 parts only.

(1). Interest expense = $162000 per year

Explanation;

Loan amount is given = $2.70 million

Interest rate is given = 6%

Annual interest ($2700000 * .06) = $162000

(2). (a). Straight line depreciation = $540000

Explanation;

Purchase costs of vehicles ($3000000) + ($3000000 * .08) = $3240000

Useful life = 5 years

Rsidual value = $540000

Straight line depreciation ($3240000 - $540000) / 5 = $540000

(b). Double-declining method;

Depreciation Expense

2016

$1296000

2017

$777600

2018

$466560

2019

$159840

2020

Nil

Explanation;

Annual depreciation rate (1 / 5) * 100 = 20%

Hence depreciation rate for Double-declining method (20% * 2) = 40%

For 2016;

($3240000 * 0.40) = $1296000

For 2017;

($1944000 * 0.40) = $777600

For 2018;

($1166400 * 0.40) = $466560

For 2019;

($699840 - $540000) = $159840

For 2020;

Nil (Because vehicles already reached at their residual value in previous year.)

(c). Units of production method;

Depreciation Expense

2016

$540000

2017

$720000

2018

$630000

2019

$630000

2020

$180000

Explanation;

Total miles to be used (15000 + 20000 + 17500 + 17500 + 5000) = 75000

Purchase costs of vehicles ($3000000) + ($3000000 * .08) = $3240000

Residual value = $540000

Hence depreciable value ($3240000 - $540000) = $2700000

For 2016;

($2700000 * 15000 / 75000) = $540000

For 2017;

($2700000 * 20000 / 75000) = $720000

For 2018;

($2700000 * 17500 / 75000) = $630000

For 2019;

($2700000 * 17500 / 75000) = $630000

For 2020;

($2700000 * 5000 / 75000) = $180000

(3) (a). Straight line;

2016

2017

2018

2019

2020

Earning before depreciation and interest

1500000

1700000

1900000

2000000

2100000

Less: Depreciation

($540000)

($540000)

($540000)

($540000)

($540000)

Income before interest

$960000

$1160000

$1360000

$1460000

$1560000

Less: Interest

($162000)

($162000)

($162000)

($162000)

($162000)

Net income

$798000

$998000

$1198000

$1298000

$1398000

Times interest earned ratio = (Income before interest / Interest)

5.92

7.16

8.39

9.01

9.63

2016

2017

2018

2019

2020

Beginning book value of vehicles

$3240000

$2700000

$2160000

$1620000

$1080000

Depreciation

($540000)

($540000)

($540000)

($540000)

($540000)

Ending book value of vehicles

$2700000

$2160000

$1620000

$1080000

$540000

Average book value of vehicles

$2970000

$2430000

$1890000

$1350000

$810000

Annual sales

$3000000

$3500000

$3800000

$3900000

$4000000

Fixed assets turnover ratio = Sales / Average book value of vehicles

1.11

1.44

2.01

2.89

4.94

Note: Average value of fixed assets have been used.

Depreciation Expense

2016

$1296000

2017

$777600

2018

$466560

2019

$159840

2020

Nil

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