Shown below are data from recent reports of two toy makers. Dollar amounts are s

Question

Shown below are data from recent reports of two toy makers. Dollar amounts are stated in thousands. 1610-9 ERCISE 10.11 Sarety of Creditors' Claims Toyco Pemco Total assets . $615,132 $2,780,500 Interest expense Operating income 28,026 39,588 13,028 304,672 a. Compute for each company (1) the debt ratio and (2) the interest coverage ratio. (Round the debt ratio to the nearest percent and the interest coverage ratio to two decimal places.) b. In your opinion, which of these companies would a long-term creditor probably view as the safer investment? Explain.

Explanation / Answer

Requirement b:

The long term creditors takes the interest coverage ratio into consideration while deciding on the investment.

Since the interest coverage ratio of Pemco is higher than that of Toyco, investment in Pemco is the saffer investment.

Exercise 10.10:

Requirement a:

Issuance of bonds:

July 1, 2015: Cash a/c (5000000 * 98) Dr $490000000

Discount on issue of bonds Dr $10000000

To Bonds payable a/c $500000000

Requirement b:

Interest payment and amortization of discount:

Dec 31, 2015

Interest Expense a/c Dr $24000000

To Interest Payable (500000000*9.5%/2) $23750000

To Discount on issue of bonds (10000000/40) $250000

Interest Payable a/c Dr $23750000

To Cash a/c $23750000

Requirement c:

Payment of interest, amortisation of discount and returement:

June 30, 2035:

Interest Expense a/c Dr $24000000

To Interest Payable (500000000*9.5%/2) $23750000

To Discount on issue of bonds (10000000/40) $250000

Interest payable a/c Dr $23750000

To Cash a/c $23750000

Bonds Payable a/c Dr $490000000

Premium on retirement Dr $10000000

To Cash a/c $500000000

Exercise 10.11: Requirement a(1): Computation of debt ratio: Debt Ratio = Total Liabilities / Total Assets Toyco Pemco Total Liabilities 349792 1105735 Total Assets 615132 2780500 Debt Ratio 0.57 0.40 Requirement a(2) Computation of interest coverage ratio: Interest Coverage Ratio = Operating Income / Interest Expense Toyco Pemco Operating Income 13028 304672 Interest Expense 28026 39588 Interest Coverage Ratio 0.46 7.70

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