The balance sheet for Shaver Corporation reported the following: cash, $5,000; s

Question

The balance sheet for Shaver Corporation reported the following: cash, $5,000; short-term investments, $10,000; net accounts receivable, $35,000; inventory, $40,000; prepaids, $10,000; equipment, $100,000; current liabilities, $40,000; notes payable (long-term), $70,000; total stockholders’ equity, $90,000; net income, $3,320; interest expense, $4,400; income before income taxes, $5,280.

The balance sheet for Shaver Corporation reported the following: cash, $5,000; short-term investments, $10,000; net accounts receivable, $35,000; inventory, $40,000; prepaids, $10,000; equipment, $100,000; current liabilities, $40,000; notes payable (long-term), $70,000; total stockholders' equity, $90,000; net income, $3,320; interest expense, $4,400; income before income taxes, $5,280. 1. Compute Shaver's debt-to-assets ratio and times interest earned ratio. (Round your answers to 2 decimal places.) Debt-to-Assets Times Interest Earned Ratio 2-a. Based on these ratios, does it appear Shaver relies mainly on debt or equity to finance its assets? Debt OEquity 2-b. Is it probable that Shaver will be able to meet its future interest obligations? Yes O No

Explanation / Answer

1) Debt to Asset: 0.55

Time interest earned ratio: 2.20

Working:

Debt to asset = (cash, $5,000 + short-term investments, $10,000 + net accounts receivable, $35,000 + inventory, $40,000 + prepaids, $10,000 + equipment, $100,000) / ( current liabilities $40,000 + notes payable (long-term), $70,000) = 200,000 / 110,000 = 0.55

$5,280 (Income Before Income Taxes) – $3,320 (Net Income) = 1,960 (Income Tax Expense)

Time interest earned ratio: (Net Income + Interest Expense + Income Tax Expense) / Interest Expense

= ($3,320 + $4,400 + $1,960**)/ $4,400 = 2.20

2) Debt because when the ratio is exceeds 0.5, most of the company's assets are financed through debt

3) Yes, Shaver will be able to meet the future interest obligations

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