Question

Catharine, Inc. is considering issuing additional long-term debt to finance an expansion. The company currently has $20 million in 5% debt outstanding. Its earnings after-tax (EAT) are $3.0 million, and its marginal and average tax rate is 40 percent. The company is required by the debt holders to maintain its times interest earned ratio at 3.0 or greater. How much additional 10 percent debt can Catharine, Inc issue now and maintain its times interest earned ratio at 3.0

Answer 1

$10 million

Step-by-step explanation:

Calculation for How much additional 10 percent debt can Catharine, Inc issue

First step is to find the EBT

EBT = $3.0 / (1 - 0.40)

EBT= $5.0

Second step is to find the EBIT

EBIT = $5.0 + $1.0

EBIT= $6.0

Third step is to find the Interest permitted using this formula

Interest permitted = EBIT / Times interest earned

Let plug in the formula

Interest permitted = $6.0 / 3.0

Interest permitted = $2.0

Fourth step is to find the Additional interest amount

Additional interest = $2.0 - $1.0

Additional interest = $1.0

Last step is to compute the Additional debt amount

Additional debt = $1.0 / 0.1

Additional debt= $10 million

Therefore the Additional debt will be $10 million