Question

Emma's Electronics Incorporated has total assets of $56 and total debt of $43 million. The company also has operating profits of $27 million with interest expenses of $8 million.

Required:
a. What is Emma's debt ratio?
b. What is Emma's times interest earned?
c. Based on the information above, would you recommend to Emma's management that the firm is in a strong enough position to assume more debt and increase interest expense to $10 million?

Answer 1

a. Debt Ratio = Debt / Total Assets

Debt Ratio = $43 million / $56 million

Debt Ratio = 0.76786

Debt Ratio = 76.79%

b. Time Interest Earned = EBIT / Interest

Time Interest Earned = $27 million / $8 million

Time Interest Earned = 3.375 times

c. If Interest expense is increased to 10 lmillion. The new Time Interest Earned = $27 million / $10 million = 2.7 times. The new time Interest Earned is at 3 times and this indicate that the company can easily raise more debt for its funding needs.