Chapter 10, Problem 5ATC

a.

To determine

Calculate the EBIT For each Company.

Explanation of Solution

EBIT (Earnings before interest and taxes):

Earnings before interest and taxes measures the organization’s profitability (includes all incomes and expenses) by excluding the interest expenses and tax implications incurred by the organization.

Calculate the EBIT (Earnings before interest and taxes):

Particulars	Incorporation JAB	Incorporation MW
Net income	$79,696	$132,063
Interest Expense	$26	$1,544
Expense	$49,147	$65,609
Earnings before interest and taxes	$128,869	$199,216

Table (1)

Conclusion

Therefore, the earnings before interest and taxes of Incorporation JAB and Incorporation MW is $128,869 and $199,216.

b.

To determine

Calculate debt-to-assets ratio, current ratio and the times-interest-earned ratio.

Explanation of Solution

Debt-to-Assets Ratio:

Debt to asset ratio is the ratio that measures the relation between total asset and total liability of the company. Debt ratio reflects the finance strategy of the company. It is used to evaluate company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.

Current ratio:

Current ratio is one type of liquidity ratios, it link between current assets and current liabilities. Thumb rule for current ratio is 2:1. The current assets are cash, marketable securities, accounts receivable, merchandise inventory, prepaid expenses and so on. Current liabilities are accounts payable, short term notes payable, short term bonds and so on.

Times Interest Earned Ratio:

It’s a measure to evaluate the net income for interest payment on debt of a company. It is a part of solvency ratios.

Calculate the debt-to- assets ratio of Incorporation JAB:

$\begin{array}{c}\text{Debt-to-assets}\text{ratio}\text{=}\frac{\text{Total}\text{liabilities}}{\text{Total}\text{Assets}}\times 100\\ \text{=}\frac{\text{\$227,284}}{\text{\$894,847}}\times 100\\ \text{=25}\text{.40\%}\end{array}$

Therefore, the debt-to-assets ratio of Incorporation JAB is 25.40%.

Calculate the debt-to- assets ratio of Incorporation MW:

$\begin{array}{c}\text{Debt-to-assets}\text{ratio}\text{=}\frac{\text{Total}\text{liabilities}}{\text{Total}\text{Assets}}\times 100\\ \text{=}\frac{\text{\$387,112}}{\text{\$1,496,347}}\times 100\\ \text{=25}\text{.90\%}\end{array}$

Therefore, the debt-to-assets ratio of Incorporation MW is 25.90%.

Calculate the current ratio of Incorporation JAB:

$\begin{array}{c}\text{Current}\text{ratio}\text{=}\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}\\ \text{=}\frac{\text{\$742,189}}{\text{\$170,349}}\\ \text{=}4.36:\text{1}\end{array}$

Therefore, the current ratio of Incorporation JAB is 4.39: 1.

Calculate the current ratio of Incorporation MW:

$\begin{array}{c}\text{Current}\text{ratio}\text{=}\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}\\ \text{=}\frac{\text{\$855,153}}{\text{\$294,183}}\\ \text{=}2.\text{91:}\text{1}\end{array}$

Therefore, the current ratio of Incorporation MW is 2.91:1.

Calculate the Times interest earned ratio of Incorporation JAB:

$\begin{array}{c}\text{Times}\text{interest earned}\text{ratio}\text{=}\frac{\text{EBIT}}{\text{Interest}\text{Expense}}\\ \text{=}\frac{\text{\$128,869}}{\text{\$26}}\\ \text{=4,956}\text{times}\end{array}$

Therefore, the Times interest earned ratio of Incorporation JAB is 4,956 times.

Calculate the Times interest earned ratio of Incorporation MW:

$\begin{array}{c}\text{Times}\text{interest}\text{earned}\text{ratio}\text{=}\frac{\text{EBIT}}{\text{Interest}\text{Expense}}\\ \text{=}\frac{\text{\$199,216}}{\text{\$1,544}}\\ \text{=129}\text{times}\end{array}$

Therefore, the Times interest earned ratio of Incorporation MW is 129 times.

c.

To determine

Calculate the return-on-assets ratio and return-on-equity ratio for each of the Incorporation.

Explanation of Solution

Return-on-assets ratio:

Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets.

Return-on-equity ratio:

Rate of return on equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common equity that is invested in the company.

Calculate the return-on-assets ratio of Incorporation JAB:

$\begin{array}{c}\text{Return-on-assets}\text{ratio}\text{=}\frac{\text{EBIT}\left(\text{Earnings}\text{Before}\text{Interest}\text{and}\text{Taxes}\right)}{\text{Total}\text{Asstes}}\times 100\\ \text{=}\frac{\text{\$128,869}}{\text{\$894,847}}\times 100\\ \text{=14}\text{.4\%}\end{array}$

Therefore, the return-on-assets ratio of Incorporation JAB is 14.4%.

Calculate the return-on-assets ratio of Incorporation MW:

$\begin{array}{c}\text{Return-on-assets}\text{ratio}\text{=}\frac{\text{EBIT}\left(\text{Earnings}\text{Before}\text{Interest}\text{and}\text{Taxes}\right)}{\text{Total}\text{Asstes}}\times 100\\ \text{=}\frac{\text{\$199,216}}{\text{\$1,496,347}}\times 100\\ \text{=13}\text{.3\%}\end{array}$

Therefore, the return-on-assets ratio of Incorporation MW is 13.3%.

Calculate the return-on-equity ratio of Incorporation JAB:

$\begin{array}{c}\text{Return-on-equity}\text{ratio}\text{=}\frac{\text{Net}\text{income}}{\text{Stockholders'}\text{equity}}\text{×100}\\ \text{=}\frac{\text{\$79,696}}{\text{\$667,563}}\text{×100}\\ \text{=11}\text{.9\%}\end{array}$

Therefore, the return-on-equity ratio of Incorporation JAB is 11.9%.

Calculate the return-on-equity ratio of Incorporation MW:

$\begin{array}{c}\text{Return-on-equity}\text{ratio}\text{=}\frac{\text{Net}\text{income}}{\text{Stockholders'}\text{equity}}\text{×100}\\ \text{=}\frac{\text{\$132,063}}{\text{\$1,109,235}}\text{×100}\\ \text{=11}\text{.9\%}\end{array}$

Therefore, the return-on-equity ratio of Incorporation MW is 11.9%.

d.

To determine

Calculate the after-tax interest expense of Incorporation MW.

Explanation of Solution

Calculate the after-tax interest rate of Incorporation MW:

$\begin{array}{c}\text{After-tax}\text{interest}\text{rate}\text{=}\frac{\text{Income}\text{tax}\text{expense}}{\text{EBIT}\left(\text{Earnings}\text{before}\text{interest}\text{and}\text{taxes}\right)}\text{×100}\\ \text{=}\frac{\text{\$65,609}}{\left(\$132,063+\$65,609\right)}\text{×100}\\ \text{=33}\text{.2\%}\end{array}$

Calculate the after tax interest expense of Incorporation MW.

$\begin{array}{c}\text{After tax interest expense = Interest expense }\times \left(\text{1}-\text{After tax interest rate}\right)\\ \text{= \$1,544}\times \left(1-33.2\%\right)\\ =\$1,031.4\end{array}$