C10-1 Calculating Interest and Depreciation Expenses and Effects on Loan Covenan

Question

C10-1 Calculating Interest and Depreciation Expenses and Effects on Loan Covenant Ratios (Chapters 9 and 10) [LO 9-3, LO 9-7, LO 10-2, LO 10-5]

Zoom Car Corporation (ZCC) plans to purchase approximately 100 vehicles on December 31, 2015, for $1.8 million, plus 10 percent total sales tax. ZCC expects to use the vehicles for 5 years and then sell them for approximately $360,000. ZCC anticipates the following average vehicle use over each year ended December 31:

   To finance the purchase, ZCC signed a 5-year promissory note on December 31, 2015, for $1.62 million, with interest paid annually at the market interest rate of 6 percent. The note carries loan covenants that require ZCC to maintain a minimum times interest earned ratio of 3.0 and a minimum fixed asset turnover ratio of 1.0. ZCC forecasts that the company will generate the following sales and preliminary earnings (prior to recording depreciation on the vehicles and interest on the note). (For purposes of this question, ignore income tax.)

Units-of-production (Enter your answers for Net Income in thousands (i.e., 50,500 should be entered as 50.5). Round "Net Income" to 1 decimal place and "Ratio Values" to 2 decimal places.)

Zoom Car Corporation (ZCC) plans to purchase approximately 100 vehicles on December 31, 2015, for $1.8 million, plus 10 percent total sales tax. ZCC expects to use the vehicles for 5 years and then sell them for approximately $360,000. ZCC anticipates the following average vehicle use over each year ended December 31:

Explanation / Answer

Answer:

Cost of Vehicles = $1.8 Million + ($1.8 Million * 110%)
Cost of Vehicles = $1.98 Million

Salvage Value = $360,000

Depreciation per Mile = (Cost – Salvage Value) / Expected Miles during the Life
Expected Miles during the Life = 12,000 + 17,000 + 10,000 + 10,000 + 5,000
Expected Miles during the Life = 54,000 Miles

Depreciation per Mile = (1,980,000 – 360,000) / 54,000
Depreciation per Mile = 1,620,000 / 54,000
Depreciation per Mile = $30

Depreciation for Year 2016 = $30 * 12,000
Depreciation for Year 2016 = $360,000

Depreciation for Year 2017 = $30 * 17,000
Depreciation for Year 2017 = $510,000

Depreciation for Year 2018 = $30 * 10,000
Depreciation for Year 2018 = $300,000

Depreciation for Year 2019 = $30 * 10,000
Depreciation for Year 2019 = $300,000

Depreciation for Year 2020 = $30 * 5,000
Depreciation for Year 2020 = $150,000

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