Question

E13-5 Computing a Commonly Used Solvency Ratio (LO 13-4, LO 13-5] According to the producer price index database maintained by the Bureau of Labor Statistics, the average cost of computer equipment fell 3.8 percent between January and December 2016. Let's see whether these changes are reflected in the income statement of Computer Tycoon Inc. for the year ended December 31, 2016. 2016 2015 Sales Revenue $110,000 65,000 45,000 37,000 $135,000 75,500 59,500 39,000 Cost of Goods Sold Gross Profit Selling, General, and Administ rative Expenses Interest Expense Income before Income Tax Expense Income Tax Expense 600 525 19,975 6,000 7,400 1,500 $ 5,900 13,975 Net Income Required: 1. Compute the times interest earned ratios for 2016 and 2015. (Round your answers to 1 decimal place.) Times Interest Earned 2015 2016

Answer 1

1)

Times Interest Earned Ratio = Earnings Before Interest and taxes ( EBIT)/ Interest Expense

EBIT = Interest before Income tax + Interest Expense

EBIT for 2015 = $ 7400+ $ 600  

                          = $ 8000

EBIT for 2016 = $ 19,975+ $ 525

                        = $ 20,500

Interest Expense Earned Ratio for 2015 = $ 8000/600

                                                                        =13.33

Interest Expense Earned Ratio for 2016 = $ 20,500/525

                                                                        =39.04

Year        Times Interest Earned

2015        13.33

2016        39.04

2) Yes the Computer Tycoon Generates sufficient Net Income to Cover the Cost of Debt Financing