Question
1. Consider the following: net operating profit after taxes = $450,000, total assets = $1,000,000, interest...
1. Consider the following: net operating profit after taxes = $450,000, total assets = $1,000,000, interest expenses = $100,000, book value (net worth) = $600,000, current liabilities = $150,000, short-term debt (notes payable) = $0, tax rate = 25%. [16 points] a. Calculate the interest coverage ratio. b. Calculate the dollar value of long-term debt on the balance sheet. c. Calculate the equity multiplier ratio. d. Management intends to partially finance a growth opportunity using long-term debt. The bond contract requires that the sum of current liabilities plus long-term debt must not exceed 50% of total assets (as reported on the most recent balance sheet). Calculate the maximum dollar amount of new long-term debt.
Answers
a. First of all we have to find EBIT. EBIT is operating profit.
Net operating profit after taxes=EBIT*(1-tax rate)
EBIT=Net operating profit after taxes/(1-tax rate)=450,000/(1-25%)=600,000
Interest coverage ratio=EBIT/Interest expenses=$600,000/$100,000=6.0x
b.Long term debt can be found using the following equation
Total assets=Total Liabilities+equity
$1,000,000=(Current liabilities+short term debt +long term debt)+600,000
400,000=(150,000+0+long term debt)
long term debt=$250,000
c.Equity multiplier ratio=Total assets/Total equity=$1,000,000/$600,000=1.67x
d. The total assets increase to 1250000 after the new long term debt issue=(50%/40%)*1,000,000
40% is the existing share of current liabilities and long term debt
Out of 1250000, current liabilities and debt should not exceed 50%
Maximum would be=50%*1250000=$625,000
Out of this $625,000, current liabiities value is $150,000. The maximum long term debt that can be used for funding is $475,000 ($625,000-$150,000)
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