Joy Global is developing a new business plan. It will require $565,000 of assets

Question

Joy Global is developing a new business plan. It will require $565,000 of assets, and they project $453,800 of sales and $365,400 of operating costs for the first year. Management is quite sure of these numbers because of contracts with its suppliers. Because it has to borrow at a rate of 9.0%, and the bank requires it to have a TIE of at least 5.0, and if the TIE falls below this level the bank will call in the loan and the company will go bankrupt. What is the maximum debt ratio Joy Global can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt ratio.)

Explanation / Answer

Earnings before interest = operating revenue - operating costs.453800 - 365400 = 88400

88400 (earnings before interest) / 5 (minimum TIE) = 17680 (interest per year)

17680 / .09 (interest rate) = $196444.4444 maximum debt

196444.4444 (maximum debt) / 565000 (assets) = .3476892822 (debt ratio)

.3476892822 is the debt ratio at which the company will go bankrupt so the maximum debt ratio for the company to still be in business is .3476892821 dollars of debt to 1 dollar of assets. This can also be written as 2.876131222 dollars of assets to 1 dollar of debt.

Related Questions

Navigate

• Browse (All)
• Browse J
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.