Question

QUESTION 1 (C10-1)

Cocao Excavating Inc. has decided to purchase 20 electric vehicles on April 30, 2019, spending

1.75 million plus 13 percent sales tax with a rebate of 2% sales instant on the spot tax break. The company expects to use the vehicles for five years and then sell them for $320,000. Cocao expects the following vehicle use over each year ended April 30:

	2019	2020	2021	2022	2023
Km per/yr.	25,000	30,000	20,000	22,000	7,000

To finance the purchase Cocao Excavating Inc. signed a five-year promissory note on December 31, 2017, for 1.4 million with interest paid annual at the market interest rate of 7 percent. The note carries loan covenants that require Cocao to maintain a minimum time interest earned ratio of 3.0 and minimum fixed asset turnover ratio of 1.0. Cocao forecasts that the company will generate the following sales and preliminary earnings (prior to recording depreciation on the vehicles and interest on the note). Income taxes can be ignored

(in thousands)	2019	2020	2021	2022	2023
Revenue	$3,000	$2,750	$3,100	$3,105	3,250
Income before depreciation and interest expense	$1,250	$1,750	$1,900	$2,050	$1,975

REQUIRED:

1. Calculate the amount of interest expense that would be recorded each year.
2. Calculate the depreciation expense that would be recorded each year, using the:
   1. Straight-line method
   2. Double Declining method
   3. Units of Production method

1. Use your answers from Question 1, and 2 to determine net income at the two loan covenant ratios in each year, assuming the company chooses the:
   1. Straight-line method
   2. Double Declining method
   3. Units of Production method

1. Using your answer to Question 3, indicate whether the loan covenants would be violated under the:
   1. Straight-line method
   2. Double Declining method
   3. Units of Production method

Answer 1

Answer 1
Interest expense (1400000*7%)			98,000
Answer 2 (a)			Straight-line depreciation
Cost of assets (1750000*1.13 = 1977500) (1977500-(1977500*2%))			1,937,950
Salvage value			320,000
Depreciable cost			1,617,950
Divided: useful life in Years			5
Depreciation expense per year			323,590
Answer 2 (b)			Double-declining-balance
Depreciation rate under (1/5 year =20%) (20%*2=40%)			40%
Book value of machine does not less than salvage value. For year 4 = 418597 - 320000 salvage value = 98597
Year	Beginning balance	Depreciation @ 40%	ending balance
1	1,937,950	775,180	1,162,770
2	1,162,770	465,108	697,662
3	697,662	279,065	418,597
4	418,597	98,597	320,000
5	320,000	-	320,000
Answer 2 (C)			Units-of-production
Cost of assets (1750000*1.13 = 1977500) (1977500-(1977500*2%))	1,937,950
Salvage value	320,000
Depreciable cost	1,617,950
Divided: useful life in miles Total of Miles (25000+30000+20000+22000+7000)	104,000
Depreciation expense per mile	$     15.557212
Year	Miles	Depreciation expense per mile	Depreciation expense
1	25,000	$ 15.557212	388,930
2	30,000	$ 15.557212	466,716
3	20,000	$ 15.557212	311,144
4	22,000	$ 15.557212	342,259
5	7,000	$ 15.557212	108,900

? X GS HOMEINSERT 2019 10 01.xlsx - Microsoft Excel DEVELOPER - 2 Sign in FILE PAGE LAYOUT FORMULAS DATA REVIEW VIEW P1 : fic J K L M N O P R I Straight-line depreciation Years 2019 Income before Depreciation and interest expense 1,250.0 Less: Depreciation expense 323.6 Income before interest expense 926.4 Less: Interest expense 98.0 Net income 828.4 2020 1,750.0 323.6 1,426.4 98.0 1.328.4 2021 1,900.0 323.6 1,576.4 98.0 1,478.4 2022 2,050.0 323.6 1,726.4 98.0 1,628.4 2023 1,975.0 323.6 1,651.4 98.0 1,553.4 Income before interest expense Divided by: Interest expense Times interest earned ratio 926.4 98.0 9.45 1,426.4 98.0 14.56 1,576.4 98.0 16.09 1,726.4 98.0 17.62 1,651.4 98.0 16.85 Beginning balance Less: Depreciation expense (in 000) Ending balance 1,938.0 323.6 1,614.4 1,614.4 323.6 1,290.8 1,290.8 323.6 967.2 967.2 323.6 643.6 643.6 323.6 320.0 Average Book value (Beginning balance+ Ending balance)/2) 1,776.2 1,452.6 1,129.0 805.4 481.8 Sales revenue Divided by: Average Book value of asset Fixed asset Turnover ratio 3,000 1,776 1.69 2,750 1,453 1.89 3,100 1,129 2.75 3,105 805 3.86 3,250 482 6.75 Double-declining-balance Years 2019 Income before Depreciation and interest expense 1,250.0 Less: Depreciation expense 775.2 Income before interest expense 474.8 2023 1,975.0 2020 1,750.0 465.1 1,284.9 2021 1,900.0 279.1 1,620.9 2022 2,050.0 98.6 1,951.4 1,975.0 ... Sheet121 Sheet122 Sheet123 Sheet124 Sheet125 Sheet127 Sheet126 Sheet128 + 7 READY Activate Windows Go to Settings to activate Windows. 60U- + 100% = ENG 09:07 US 30-10-19 Search the web and Windows

? X GS HOMEINSERT 2019 10 01.xlsx - Microsoft Excel DEVELOPER - 2 Sign in FILE PAGE LAYOUT FORMULAS DATA REVIEW VIEW P47 : for H M N O P Q I 1.69 R S T U J 1.89 K 2.75 L 3.86 Fixed asset Turnover ratio 6.75 2023 1,975.0 Double-declining-balance Years 2019 Income before Depreciation and interest expense 1,250.0 Less: Depreciation expense 775.2 Income before interest expense 474.8 Less: Interest expense 98.0 Net income 376.8 2020 1,750.0 465.1 1,284.9 98.0 1,186.9 2021 1,900.0 279.1 1,620.9 98.0 1,522.9 2022 2,050.0 98.6 1,951.4 98.0 1,853.4 1,975.0 98.0 1,877.0 Income before interest expense Divided by: Interest expense Times interest earned ratio 474.8 98.0 4.85 1,284.9 98.0 13.11 1,620.9 98.0 16.54 1,951.4 98.0 19.91 1,975.0 98.0 20.15 320.0 Beginning balance Less: Depreciation expense (in 000) Ending balance 1,938.0 775.2 1,162.8 1,162.8 465.1 697.7 697.7 279.1 418.6 418.6 98.6 320.0 320.0 Average Book value ((Beginning balance+ Ending balance)/2) 1,550.4 930.2 558.1 369.3 320.0 Sales revenue Divided by: Average Book value of asset Fixed asset Turnover ratio 3,000 1,550 1.94 2,750 930 2.96 3,100 558 5.55 3,105 369 8.41 3,250 320 10.16 Units-of-production Years 2019 Income before Depreciation and interest expense 1,250.0 ... Sheet121 Sheet122 Sheet123 Sheet124 Sheet125 Sheet127 2020 1,750.0 2021 1,900.0 2022 2,050.0 2023 1,975.0 Sheet126 Sheet128 + Activate Windows Go to Settings to activate Windows. D U - 100% = ENG 09:07 US 30-10-19 READY Search the web and Windows

? X GS HOMEINSERT 2019 10 01.xlsx - Microsoft Excel DEVELOPER - 2 Sign in FILE PAGE LAYOUT FORMULAS DATA REVIEW VIEW P71 x fic J K L M N O P Q R S T U A I Units-of-production Years 2019 Income before Depreciation and interest expense 1,250.0 Less: Depreciation expense 388.9 Income before interest expense 861.1 Less: Interest expense 98.0 Net income 763.1 2020 1,750.0 466.7 1,283.3 98.0 1,185.3 2021 1,900.0 311.1 1,588.9 98.0 1,490.9 2022 2,050.0 342.3 1,707.7 98.0 1,609.7 2023 1,975.0 108.9 1,866.1 98.0 1,768.1 Income before interest expense Divided by: Interest expense Times interest earned ratio 861.1 98.0 8.79 1,283.3 98.0 13.09 1,588.9 98.0 16.21 1,707.7 98.0 17.43 1,866.1 98.0 19.04 428.9 Beginning balance Less: Depreciation expense (in 000) Ending balance 1,938.0 388.9 1,549.0 1,549.0 466.7 1,082.3 1,082.3 311.1 771.2 771.2 342.3 428.9 108.9 320.0 Average Book value (Beginning balance+ Ending balance)/2) 1,743.5 1,315.7 926.7 600.0 374.5 3,105 Sales revenue Divided by: Average Book value of asset Fixed asset Turnover ratio 3,000 1,743 1.72 2,750 1,316 2.09 3,100 927 3.35 600 3,250 374 8.68 5.17 Answer 4 Under straight line method, loan covenants would not be violated. Under Double-declining-balance, loan covenants would not be violated. Under Units-of-production, loan covenants would not be violated. 72 ... Sheet121 Sheet122 Sheet123 Sheet124 Sheet125 Sheet127 Sheet126 Sheet128 + - READY Activate Windows Go to Settings to activate Windows. D U - 100% = ENG 09:07 US 30-10-19 Search the web and Windows x]