Previous Lecture Summary

• Long Term Debt-Paying Ability

• Income Statement Consideration when Determining
Long-Term Debt-Paying Ability,
• Times Interest Earned
• Fixed Charge Coverage
• Practical Exercises
 Practical Exercise
You have been asked to evaluate the long-term borrowing position of
Client, Inc. However, you were given only the following limited
information.
Bonds payable, 12% $1,000,000
Stockholders' equity 1,800,000
Current assets 1,870,000
Tangible assets, net 1,600,000
Intangible assets 40,000
Investments 120,000
Other assets 90,000
Sales 4,000,000
Operating expenses 3,620,000

Required:
Assuming that this is the only information you will receive, estimate
the following ratios:
Practical Exercise (cont’d)
a. Times interest earned ratio

b. Debt ratio

c. Debt/equity ratio

d. Debt to tangible net worth ratio

The following information is computed from Fast Food
Chain’s annual report for 2010. 2010 2009
Current assets $ 2,731,020 $ 2,364,916
Property and equipment, net 10,960,286 8,516,833
Intangible assets, at cost
less applicable amortization 294,775 255,919
$13,986,081 $11,137,668

Current liabilities $ 3,168,123 $ 2,210,735

Deferred federal income taxes 160,000 26,000
Mortgage note payable 456,000 —
Stockholders' equity 10,201,958 8,900,933
$13,986,081 $11,137,668

Net sales $33,410,599 $25,804,285

Cost of goods sold (30,168,715) (23,159,745)
Selling and administrative expense (2,000,000) (1,500,000)
Interest expense (216,936) (39,456)
Income tax expense (400,000) (300,000)
Net income $ 624,948 $ 805,084
 Practical Exercise (cont’d)
Note: One-third of the operating lease rental charge was $100,000 in 2010
and $50,000 in 2009. Capitalized interest totaled $30,000 in 2010
and $20,000 in 2009.
Required:
a. Based on the above data for both years, compute:
1. Times interest earned
2. Fixed charge
3. Debt ratio
4. Debt/equity ratio
5. Debt to tangible net worth
b. Comment on the firm's long-term borrowing ability based on
the analysis.
The following financial information is excerpted from the 2010 annual report
of Retail Products, Inc.
Balance Sheet
(in thousands)
2010 2009
Current assets $ 449,195 $ 433,049
Investments 32,822 55,072
Deferred charges 4,905 12,769
Property, plant, and equipment, net 350,921 403,128
Trademarks and leaseholds 45,031 47,004
Excess of cost over fair market
value of net assets acquired 272,146 276,639
Assets held for disposal 6,062 10,247
$ 1,161,082 $1,237,908

Total liabilities $ 689,535 $ 721,149

Total stockholders' equity 471,547 516,759
$ 1,161,082 $1,237,908

Income Statement
Net sales $ 2,020,526 $1,841,738
Cost of goods sold (2,018,436) (1,787,126)
Selling and administrative (300,000) (250,000)
Interest expense (40,000) (30,000)
Net income (loss) $ (337,910) $ (225,388)
 Practical Exercise (cont’d)
Required:
For each year compute:

a. 1. Times interest earned

2. Debt ratio
3. Debt/equity ratio
4. Debt to tangible net worth ratio
b. Comment on the results.
c. Does a times interest earned ratio of less than
1 to 1 mean that the firm cannot pay its interest
expense?