Russell Securities has $100 million in total assets and its corporate tax rate i

Question

Russell Securities has $100 million in total assets and its corporate tax rate is 40 percent. The company recently reported that its basic earning power (BEP) ratio was 15 percent and that its return on assets (ROA) was 9 percent. What was the company's interest expense?

$                0

$ 2,000,000

$ 6,000,000

$15,000,000

$18,000,000

Last year, Quayle Energy had sales of $200 million, and its inventory turnover ratio was 5.0. The company's current assets totaled $100 million, and its current ratio was 1.2. What was the company's quick ratio?

1.20

1.39

0.72

0.55

e.2.49

Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's current TIE ratio?

2.4

3.4

3.6

4.0

e. 5.0

$                0

$ 2,000,000

$ 6,000,000

$15,000,000

$18,000,000

Explanation / Answer

Part A)

We will have to calculate the EBIT (Earnings Before Interest and Taxes) with the use of BEP and total assets. The formula for calculating EBIT can be derived as follows:

EBIT = BEP*Total Assets

We will also have to calculate EBT (Earnings Before Taxes) with the use of net income and taxes. The net income will be calculated with the use of ROA and total assets. The formula for calculating EBIT can be derived as follows:

Net Income = ROA*Total Assets

EBT = Net Income/(1-Tax Rate)

______________

Using the values in the question, we get,

EBIT = 15%*100,000,000 = $15,000,000

_____

Net Income = 9%*100,000,000 = $9,000,000

EBT = 9,000,000/(1-40%) = $15,000,000

_____

Since, EBIT and EBT are same at $15,000,000, we can conclude that interest expense is 0 (which is Option A)

______________

Part B)

We will have to calculate the value of inventory with the use of sales and inventory turnover ratio. Also, we need to determine the value of current liabilities with the use of current assets and current ratio. Relevant formulas are:

Value of Inventory = Sales/Inventory Turnover Ratio

Current Liabilities = Current Assets/Current Ratio

Quick Ratio = (Current Assets - Value of Inventory)/Current Liabilities

______________

Using the values in the question, we get,

Value of Inventory = 200/5 = $40 million

Current Liabilities = 100/1.2 = $83.33 million

_____

Quick Ratio = (100 - 40)/83.33 = .72 (which is Option C)

______________

Part C)

The times interest earned ratio can be calculated with the use of EBIT and interest. We will have to calcuate the net income with the of sales and profit margin to arrrive at EBIT. Interest will be calculated with the use of debt and interest rate. Relevant formulas are:

Net Income = Sales*Profit Margin

EBIT = Net Income/(1-Tax Rate) + Interest

Interest Rate = Value of Debt Outstanding*Interest Rate

TIE Ratio = EBIT/Interest

______________

Using the values in the question, we get,

Net Income = 3,200,000*6% = $192,000

EBIT = 192,000/(1-40%) = $320,000 + 800,000*10% = $400,000

_____

TIE = 400,000/80,000 = 5 (which is Option E)

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