1、1Chapter 7Long-Term Debt-Paying AbilityPROBLEMSPROBLEM 7-1 Inters dCapilzcluigEx,IntersaMoyEn,qT Ex,tgRcuarnedItsTimeEarnings before interest and tax:Net sales $1,079,143Cost of sales ( 792,755)Selling and administration ( 264,566)$ 21,822a. yearptims06.531,4$82EarnedItsTimeb. Cash basis times inter
2、est earned: er6131,4$082PROBLEM 7-2Recurring Earnings Excluding Interest Expense, Tax Expense, Equity Earnings, a. Times Interest Earned = and Minority Earnings Interest Expense, Including Capitalized InterestIncome before income taxes $675Plus interest 60Adjusted income $735Interest expense $ 60Tim
3、es Interest Earned = $735 = 12.25 times per year$60b. Rentals ofPriIntesrdCpzcludg Exp,IntesaigMriyaqyT ExIRcuCoverag hFixed2Adjusted income from (part a) $7351/3 of operating lease payments(1/3 x $150) 50Adjusted income, including rentals $785Interest expense $ 601/3 of operating lease payments 50$
4、110Fixed Charge Coverage = $785 = 7.14 times per year$110PROBLEM 7-3Recurring Earnings, Excluding Interest Expense, Tax Expense, Equity Earning, a. Times Interest Earned = and Minority Earnings_ Interest Expense, Including Capitalized InterestIncome before income taxes andextraordinary charges $36Pl
5、us interest 16(1) Adjusted income 52(2) Interest expense $16Times Interest Earned: (1) divided by (2) = 3.25 times per yearRecurring Earnings, Excluding InterestExpense, Tax Expense, Equity Earnings,and Minority Earnings + Interest Portionb. Fixed Charge Coverage = Of Rentals_ Interest Expense, Incl
6、uding CapitalizedInterest + Interest Portion Of RentalsAdjusted income (part a) $ 521/3 of operating lease payments(1/3 x $60) 20(l) Adjusted income, including rentals $72Interest expense $161/3 of operating lease payments 20(2) Adjusted interest expense $36Fixed charge coverage: (1) divided by (2)
7、= 2.00 times per year3PROBLEM 7-4a. Debt Ratio = 41.2%$2,0179AsetToalLibb. Debt/Equity Ratio = 709Equity rSckhdsalec. Ratio of Total Debt to Tangible Net Worth =Total Liabilities = $174,979 = $174,979 = 70.9%Tangible Net Worth $249,222 - $2,324 $246,898d. Kaufman Company has financed over 41% of its
8、 assets by the use of funds from outside creditors. The Debt/Equity Ratio and the Debt to Tangible Net Worth Ratio are over 70%. Whether these ratios are reasonable depends upon the stability of earnings.PROBLEM 7-5RatioTransactionTimesInterestEarnedDebtRatioDebt/EquityTotal Debt/TangibleNet Wortha.
9、 Purchase of buildings financed by mortgageb. Purchase inventory on short-term loanc. Declaration and payment of cash dividendd. Declaration and payment of stock dividende. Firm increases profits by cutting cost of salesf. Appropriation of retained earningsg. Sale of common stockh. Repayment of long
10、-term bank loani. Conversion of bonds to common stock j. Sale of inventory at greater than cost-00+00+0-0-+0-0-+0-0-56PROBLEM 7-6a. Times Interest Earned:Times interest earned relates earnings before interest expense, tax, minority earnings, and equity income to interest expense. The higher this rat
11、io, the better the interest coverage. The times interest earned has improved materially in strengthening the long-term debt position. Considering that the debt ratio and the debt to tangible net worth have remained fairly constant, the probable reason for the improvement is an increase in profits.Th
12、e times interest earned only indicates the interest coverage. It is limited in that it does not consider other possible fixed charges, and it does not indicate the proportion of the firms resources that have come from debt.Debt Ratio:The debt ratio relates the total liabilities to the total assets.T
13、he lower this ratio, the lower the proportion of assets that have been financed by creditors.For Arodex Company, this ratio has been steady for the past three years. This ratio indicates that about 40% of the total assets have been financed by creditors. For most firms, a 40% debt ratio would be con
14、sidered to be reasonable.The debt ratio is limited in that it relates liabilities to the book value of total assets. Many assets would have a value greater than book value. This tends to overstate the debt ratio and, therefore, usually results in a conservative ratio. The debt ratio does not conside
15、r immediate profitability and, therefore, can be misleading as to the firms ability to handle long-term debt.Debt to Tangible Net Worth:The debt to tangible net worth relates total liabilities to shareholders equity less intangible assets. The lower this ratio, the lower the proportion of tangible a
16、ssets that has been financed by creditors.Arodex Company has had a stable ratio of approximately 81% for the past three years. This indicates that creditors have financed 81% as much as the shareholders after eliminating intangibles from the shareholders contribution-for most firms, this would be co
17、nsidered to be reasonable. The debt to tangible net worth ratio is more conservative than the debt ratio because of the 7elimination of intangible items. It is also conservative for the same reason that the debt ratio was conservative, in that book value is used for the assets and many assets have a
18、 value greater than book value. The debt to tangible net worth ratio also does not consider immediate profitability and, therefore, can be misleading as to the firms ability to handle long-term debt.Collective inferences one may draw from the ratios of Arodex, Company:Overall it appears that Arodex
19、Company has a reasonable and improving long-term debt position. The debt ratio and the debt to tangible net worth ratios indicate that the proportion of debt appears to be reasonable. The times interest earned appears to be reasonable and improving.The stability of earnings and comparison with indus
20、try ratios will be important in reaching a conclusion on the long-term debt position of Arodex Company.b. Ratios are based on past data. The future is what is important, and uncertainties of the future cannot be accurately determined by ratios based upon past data.Ratios provide only one aspect of a
21、 firms long-term debt-paying ability. Other information, such as information about management and products, is also important.A comparison of this firms ratios with ratios of other firms in the same industry would be helpful in order to decide if the ratios are reasonable.PROBLEM 7-7Recurring Earnin
22、gs, Excluding Interesta. 1. Times Interest Expense, Tax Expense, Equity Earnings,Earned = and Minority Earnings_ Interest Expense, IncludingCapitalized Interest$162,000 = 8.1 times per year $ 20,0002. Debt Ratio = Total LiabilitiesTotal Assets$193,000 = 32.2%$600,00083. Debt/Equity Ratio = Total Lia
23、bilities Stockholders Equity$193,000 = 47.4%$407,00094. Debt to Tangible Net Worth Ratio = Total LiabilitiesTangible Net Worth$193,000 = 49.9%$407,000 - $20,000b. New asset structure for all plans:AssetsCurrent assets $226,000Property, plant, andequipment 554,000Intangibles 20,000Total assets $800,0
24、00Liabilities and EquityPlan ACurrent Liabilities $ 93,000 $200,000,000/100 =Long-term debt 100,000 2,000,000 sharesPreferred stock 250,000Common equity 357,000 No change in net income$800,000Plan BCurrent liabilities $ 93,000 $200,000,000/10 =Long-term debt 100,000 20,000,000 sharesPreferred stock
25、50,000Common stock 120,000Premium on common stock 300,000Retained earnings 137,000 No change in net income$800,000Plan CCurrent liabilities $ 93,000 Operating Income $162,000Long-term debt 300,000 Interest expense 52,000*Preferred stock 50,000 110,000Common equity 357,000 Taxes (40%) 44,000$800,000
26、Net Income $ 66,000* $20,000 + 16% ($200,000) = $52,0001. Recurring Earnings, Excluding Interest Expense,Times Interest Tax Expense, Equity Earnings, and Minority EarningsEarned = Interest Expense, Including Capitalized InterestPlan A Plan B Plan C12times1.80,2$16times1.80,2$16times1.30,52$62. Debt
27、= Total Liabilities Ratio Total AssetsPlan A Plan B Plan C%1.240,8$193 %1.240,8$193%1.490,8$33. Debt/Equity Ratio = Equity rsStockhldeLabTPlan A Plan B Plan C%8.310,67$9%8.310,67$9%6.90,47$34. Debt to Tangible Net Worth = WorthNeTangiblsLotPlan A Plan B Plan C%9.32$0,-67193329%$0,-6719310.6%$2,-4073
28、9c. Preferred Stock Alternative:Advantages:1. Lesser drop in earnings per share than under the common stock alternative.2. Not the absolute reduction in earnings that accompanied the debt alternative.3. There would be an improvement in the Debt Ratio, Debt/Equity Ratio, and Total Debt to Tangible Ne
29、t Worth Ratio.4. Does not have the reduced times interest earned that accompanied alternative of issuing long-term debt.Disadvantages:101. An increase in the fixed preferred dividend charge that the firm must pay before any dividends can be paid to common stockholders.11Common Stock Alternative:Adva
30、ntages:1. No increase in fixed obligations.2. There would be an improvement in the Debt Ratio, Debt/Equity Ratio, and the Total Debt to Tangible Net Worth Ratio.3. Not the absolute reduction in earnings that accompanied the debt alternative.4. Does not have the reduced times interest earned that acc
31、ompanied alternative of issuing long-term debt.Disadvantages:1. Maximum dilution in earnings per share of the three alternatives.Long-Term Bonds Alternative:Advantages:1. Higher earnings per share than with common stock.Disadvantages:1. Material decline in Times Interest Earned.2. A material increas
32、e in the Debt Ratio, Debt/Equity Ratio,and Total Debt to Tangible Net Worth Ratio.3. Absolute reduction in earnings.4. Increase in the interest fixed charge that must be paid.d. The 10% preferred stock increased the preferred dividends which are not tax deductible; therefore, the cost of these funds
33、 is the 10% amount. The 16% bonds are tax deductible and, therefore, the after-tax cost is 9.6% (16% x (1-.40).Note to Instructor: You may want to take this opportunity to point out to the students that the alternative that should be selected is greatly influenced by the change in earnings and the s
34、pecific debt structure. The conclusions in this problem would not necessarily be true with changed assumptions.12PROBLEM 7-8a. Times Interest Earned = Inters dCapilzcuigExIntersEaMoyEg,q,TEarnings from continuing operations beforeincome taxes and equity earnings(1) Add back interest expense (1) $ 74
35、,780,000(2) Adjusted earnings (2) $ 37,646,000$112,426,000Times interest earned: (2) divided by (1) 1.99 timesper yearb. Earnings from continuing operationsPlus:(1) Interest $ 65,135,000Income taxes 37,394,000(2) Adjusted earnings $140,175,000Times interest earned: (2) divided by (1) 3.72 timesper y
36、earc. Removing equity earnings gives a more conservative times interest earned ratio. The equity income is usually substantially more than the cash dividend received from the related investments. Therefore, the firm cannot depend on this income to cover interest payments.PROBLEM 7-9a. 1. Times Inter
37、est Earned = Inters dCapilzcluigEx,IntersaMoyEn,qTEx,tgRcutimes9.5$10, m5.3$32,0172. Debt Ratio = %946Equty rShaoldLbT58.4%$,073. Debt Equity = 81.$19,0iseet21134. Debt to Tangible Net Worth = %5.86$1,0-96sIntagible-EquiyrsShaeoldLblTt %4.170,2$4157b. No, Barker Company has a times interest earned o
38、f 5.3 times while the industry average is 7.2 times. This indicates that Barker Company has less than average coverage of its interest. Also, Barker Company has a much higher than average debt/equity, and debt to tangible net worth ratio.c. Allen Company has a better times interest earned, debt rati
39、o, debt/equity, and debt to tangible net worth.PROBLEM 7-10a. 1. Times Interest Earned = 2004: $280,000 - $156,000 = 7.29 times per year$17,0002003: $302,000 - $157,000 = 9.06 times per year$16,0002002: $286,000 - $154,000 = 8.80 times per year$15,0002001: $270,000 - $150,000 = 8.28 times per year$1
40、4,5002000: $248,000 - $147,000 = 4.39 times per year$23,00014Recurring Earnings, ExcludingInterest, Tax Expense, EquityEarnings, and Minority Earnings +2. Fixed Charge Coverage = Interest Portion of Rentals Interest Expense, Including Capitalized Interest + InterestPortion of Rentals2004: $280,000 -
41、 $156,000 + $10,000 = 4.96 times per year$17,000 + $10,0002003: $302,000 - $157,000 + $9,000 = 6.16 times per year$16,000 + $9,000 2002: $286,000 - $154,000 + $9,500 = 5.78 times per year$15,000 + $9,5002001: $270,000 - $150,000 + $10,000 = 5.31 times per year$14,500 + $10,0002000: $248,000 - $147,0
42、00 + $9,000 = 3.44 times per year$23,000 + $9,0003. Debt Ratio = Total LiabilitiesTotal Assets2004: $88,000 + $170,000 = 46.07%$560,0002003: $89,500 + $168,000 = 46.48%$554,0002002: $90,500 + $165,000 = 46.14%$553,8002001: $90,000 + $164,000 = 46.31%$548,5002000: $91,500 + $262,000 = 65.83%$537,0001
43、54. Debt/Equity = Total Liabilities Shareholders Equity2004: $88,000 + $170,000 = 85.43%$302,0002003: $89,500 + $168,000 = 86.85%$296,5002002: $90,500 + $165,000 = 85.65%$298,3002001: $90,000 + $164,000 = 86.25%$294,5002000: $91,500 + $262,000 = 192.64%$183,5005. Debt to Tangible Net Worth = Total L
44、iabilities Shareholders Equity -Intangible Assets2004: $88,000 + $170,000 = 91.49%$302,000 - $20,0002003: $89,500 + $168,000 = 92.46%$296,500 - $18,0002002: $90,500 + $165,000 = 90.83%$298,300 - $17,0002001: $90,000 + $164,000 = 91.20%$294,500 - $16,0002000: $91,500 + $262,000 = 209.79%$183,500 - $1
45、5,000b. Both the times interest earned and the fixed charge coverage are good. The times interest earned is substantially better than the fixed charge coverage because of the operating leases. Both of these ratios materially declined in 2004.The debt ratio, debt/equity, and debt to tangible net worth materially improved between 2000 and 2001. During the period 2001-2004, these ratios were relatively steady and appeared to be good. The debt to tangible net worth ratio is not as good as the debt/equity ratio because of the influence of intangibles.
