Next year\'s expected net income after tax, but before new financing -------- $8

Question

Next year's expected net income after tax, but before new financing -------- $80 Million

Sinking-fund payments due next year on existing debt ---------------------------$23 Million

Interest due next year on existing debt------------------------------------------------$14 Million

Company Tax Rate--------------------------------------------------------------------------35%

Common Stock Price-----------------------------------------------------------------------$32

Common Shares outstanding------------------------------------------------------------30 Million

1. Calculate the times interest earned ratio for next year assuming the firm raises $40 million of new debt at an interest rate of %6

2. Calculate the times burden covered ratio for next year assuming annual sinking fund payments on the new debt will equal $10 million.

Explanation / Answer

1. Interest earned ratio = EBIT / Interest Expense
EBIT = [80 / (1 - 0.35)] + 14 = $137.08 million
Interest = 14 + (40 x 6%) = $38 million
Interest earned ratio = 137.08 / 38 = 3.61 times

2. Times burden covered ratio = EBIT / (Interest + Principal Repayment / (1-TaxRate))
= 137.08 / ((14 + 24) + (23 + 10)/(1-0.35)) = 1.54 times

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