A start-up company is seeking your advice concerning its debt ratio and capital
ID: 2637129 • Letter: A
Question
A start-up company is seeking your advice concerning its debt ratio and capital structure decisions. It will require $1,000,000 of total assets and anticipates sales during its first year of operation to be $760,000. The sum of its operating costs and cost of goods sold will be $625,000. The company can borrow funds at an interest rate of 7.5% however, because of its high-risk business plan, the lender will require the firm to maintain a TIE (times-interest-earned) ratio of at least 5.5x. What is the maximum debt ratio the firm can use so as to meet its TIE ratio of 5.5x?
Explanation / Answer
TIE (times-interest-earned) ratio = EBIT / INTEREST
=> 5.5X = $135,000 / INTEREST
=> INTEREST = 135,000 / 5.5
=> $24,545
So interest amount is this, then total amount of Debt to be = Interest amount / interest rate
=> $24,545 /7.5%
Total amount of debt = $327,273
=> %of debt = $327,273 / $1,000,000
=> 32.73 % (rounded off)
=> The maximum % of debt to be raised is = 32.73%
Particulars $ Sales 760,000 COGS & Operating expenses (625,000) EBIT 135,000Related Questions
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