Question

Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's current TIE ratio?

Answer 1

Answer:

The company's TIE is 5

Which is above the requirement of the bank.

Explanation:

TIE = income before interest and taxes / interest expense

The first step, is calculate the interest expense:

debt outstanding x debt rate

interest expense: 800,000 x 10% = 80,000

(if there were more than one type of debt, then we should calculate all the interest expense and add them together)

Then we calculate the EBIT (earnings before interest and taxes)

3,200,000 sales

x 6% profit margin:

192,000 net income.

This is the income after taxes and interest

we need to discount this figures.

(EBIT - interest expense) x ( 1 - tax-rate) = net income

(EBIT - 80,000) x ( 1 - 40%) = 192,000

EBIT - 80,000 = 192,000/0.6

EBIT = 320,0000 + 80,000 = 400,000

Now we are able to calculate the TIE ratio:

400,000/80,000 = 5