Question

A business has net income of 100,000, income taxes of 20,000, and interest expense of 40,000. Based on this information, its times interest earned ratio is 4:1, which is calculated as?

Answer 1

The times interest earned ratio is 3:1, calculated by adding the net income ($100,000) and income taxes ($20,000) to get $120,000, then dividing by the interest expense ($40,000).

Step-by-step explanation:

The times interest earned ratio is calculated by taking the sum of net income, income taxes, and interest expense, then dividing that sum by the interest expense. In this scenario, the business has a net income of $100,000, income taxes of $20,000, and interest expense of $40,000. To calculate the times interest earned ratio, we add the net income and income taxes to get the earnings before interest and taxes (EBIT), which would be $100,000 + $20,000 = $120,000. We then divide the EBIT by the interest expense: $120,000 ÷ $40,000 = 3. The students might be confused because they are mentioning a ratio of 4:1, but according to the calculation, it should actually be 3:1.

Here's how the calculation works:

1. Add net income and income taxes: $100,000 + $20,000 = $120,000.
2. Divide the sum by the interest expense: $120,000 ÷ $40,000 = 3.

Therefore, the correct times interest earned ratio is 3:1, not 4:1.