Question

The Morris Corporation has $300,000 of debt outstanding, and it pays an interest rate of 8% annually. Morris's annual sales are $1.5 million, its average tax rate is 35%, and its net profit margin on sales is 7%. If the company does not maintain a TIE ratio of at least 5 to 1, its bank will refuse to renew the loan and bankruptcy will result. What is Morris's TIE ratio?

Answer 1

TIE Ratio = 7.731

Step-by-step explanation:

Provided information we have,

TIE Ratio =
`(EBIT)/(Interest)`

Interest = $300,000
`*` 8% = $24,000

Net profit = Sales
`*` Net profit margin = $1.5 million
`*` 7% = $105,000

Now this profit is after tax,

Profit - 35% of profit = $105,000

65% of profit = $105,000

Profit before taxes =
`(105,000)/(0.65) = 161,538.46`

Profit before taxes + Interest = Earnings before interest and taxes = $161,538.46 + $24,000 = $185,538.46

Therefore,

TIE Ratio =
`(185,538.46)/(24,000) = 7.731`

Therefore, the bank will renew the loan as the TIE Ratio is more than 5.