In 2013, Natural Selection, a nationwide computer dating service, had $500 milli

Question

In 2013, Natural Selection, a nationwide computer dating service, had $500 million of assets and $200 million of liabilities. Earnings before interest and taxes were $120 million, interest expense was $28 million, the tax rate was 40%, principal repayment requirements were $24 million, and annual dividends were 30 cents per share on 20 million shares outstanding.

a) Calculate the following for Natural Selection:

1) Liabilities-to-equity ratio

2) Times-interest-earned ratio

3) Times burden covered

b) What percentage decline in earnings before interest and taxes could Natural Selection have sustained before failing to cover:

1) Interest payment requirements?

2) Principal and interest requirements?

3) Principal, interest, and common dividend payments?

Explanation / Answer

a)

Liabilities to equity ratio = 200/(500-200) = 0.667

Times interest earned ratio = EBIT/Interest expense = 120/28 = 4.285

Times burden covered = EBIT / (Interest +Principal repayment/(1-tax rate)) = 120/(28+24/(1-0.4)) = 1.764

b)

Interest paying requirements - Times earned ratio has to fall below 1

= (128-20)/120 = 76.7%

Principal and interest requirements - Times burden cover ratio has to fall below 1

= [120-(28+24/(1-0.4))]/120 = 0.433 or 43.3%

Principal, Interest and Common dividend payments -

[120-(28+((24+0.3*20)/(1-0.4))]/120 = 0.35 or 35%

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