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Concept Introduction:
Times Interest earned:
Times interest earned is used to assess the company's ability to meet its interest payment dues. The following formula is used to calculate the ratio.
Requirement 1:
To Compute:
The times interest earned for the given companies
Answer to Problem 5BPSB
The times interest earned for Ellis Company is 1.33 and the times interest earned for Seidel Company is 2
Explanation of Solution
| Ellis Company | Seidel Company | |
| Income before Interest | 120,000 | 60,000 |
| Interest Expenses | 90,000 | 30,000 |
| Times Interest Earned |
|
|
Thus, the times interest earned have been calculated for two companies.
Concept Introduction:
Times Interest earned:
Times interest earned is used to assess the company's ability to meet its interest payment dues. The following formula is used to calculate the ratio.
Requirement 2:
The impact of sales increase by 10% on each company's net income
Answer to Problem 5BPSB
When sales increase by 10%, the Net Income of Ellis Company becomes $ 42,000 from $30,000 resulting in 40% increase over previous profits. For Seidel Company the profit increases from $ 30,000 to $36,000 resulting in 20% increase over last profits.
Explanation of Solution
| Ellis Company | Seidel Company | |||||
| Present | Increased sales by 10% | Increase /(Decrease ) in %age | Present | Increased sales by 10% | Increase /(Decrease ) in %age | |
| Sales | 240,000 | 264,000 | 10% | 240,000 | 264,000 | 10% |
| Variable Expenses | 120,000 | 132,000 | 10% | 180,000 | 198,000 | 10% |
| Income before Interest | 120,000 | 132,000 | 10% | 60,000 | 66,000 | 10% |
| Interest Expense (fixed) | 90,000 | 90,000 | 0% | 30,000 | 30,000 | 0% |
| Net Income | 30,000 | 42,000 | 40% | 30,000 | 36,000 | 20% |
Thus, the impact of sales increase has been calculated.
Concept Introduction:
Times Interest earned:
Times interest earned is used to assess the company's ability to meet its interest payment dues. The following formula is used to calculate the ratio.
Requirement 3:
The impact of sales increase by 40% on each company's net income
Answer to Problem 5BPSB
When sales increase by 40%, the Net Income of Ellis Company becomes $ 78,000 from $30,000 resulting in 160% increase over previous profits. For Seidel Company the profit increases from $ 30,000 to $54,000 resulting in 80% increase over last profits.
Explanation of Solution
| Ellis Company | Seidel Company | |||||
| Present | Increased sales by 40% | Increase /(Decrease ) in %age | Present | Increased sales by 40% | Increase /(Decrease ) in %age | |
| Sales | 240,000 | 336,000 | 40% | 240,000 | 336,000 | 40% |
| Variable Expenses | 120,000 | 168,000 | 40% | 180,000 | 252,000 | 40% |
| Income before Interest | 120,000 | 168,000 | 40% | 60,000 | 84,000 | 40% |
| Interest Expense (fixed) | 90,000 | 90,000 | 0% | 30,000 | 30,000 | 0% |
| Net Income | 30,000 | 78,000 | 160% | 30,000 | 54,000 | 80% |
Thus, the impact of sales increase have been calculated
Times Interest earned:
Times interest earned is used to assess the company's ability to meet its interest payment dues. The following formula is used to calculate the ratio.
Requirement 4:
The impact of sales decrease by 20% on each company's net income
Answer to Problem 5BPSB
When sales decrease by 20%, the Net Income of Ellis Company becomes $ 6,000 from $30,000 resulting in 80% decrease over previous profits. For Seidel Company the profit decreases from $ 30,000 to $18,000 resulting in 40% decrease over last profits.
Explanation of Solution
| Ellis Company | Seidel Company | |||||
| Present | Decreased sales by 20% | Increase /(Decrease ) in %age | Present | Decreased sales by 20% | Increase /(Decrease ) in %age | |
| Sales | 240,000 | 192,000 | (20%) | 240,000 | 192,000 | (10%) |
| Variable Expenses | 120,000 | 96,000 | (20%) | 180,000 | 144,000 | (10%) |
| Income before Interest | 120,000 | 96,000 | (20%) | 60,000 | 48,000 | (10%) |
| Interest Expense (fixed) | 90,000 | 90,000 | 0% | 30,000 | 30,000 | 0% |
| Net Income | 30,000 | 6,000 | (80%) | 30,000 | 18,000 | (40%) |
Concept Introduction:
Times Interest earned:
Times interest earned is used to assess the company's ability to meet its interest payment dues. The following formula is used to calculate the ratio.
Requirement 5:
The impact of sales decrease by 50% on each company's net income
Answer to Problem 5BPSB
When sales decrease by 50%, the Net Income of Ellis Company decreases from $ 30,000 to loss of $30,000 resulting in 200% decrease over last profits. For Seidel Company the profit decreases to nil from $30,000 resulting in 100% decrease over previous profits.
Explanation of Solution
| Ellis Company | Seidel Company | |||||
| Present | Decreased sales by 50% | Increase /(Decrease ) in %age | Present | Decreased sales by 50% | Increase /(Decrease ) in %age | |
| Sales | 240,000 | 120,000 | (50%) | 240,000 | 120,000 | (50%) |
| Variable Expenses | 120,000 | 60,000 | (50%) | 180,000 | 90,000 | (50%) |
| Income before Interest | 120,000 | 60,000 | (50%) | 60,000 | 30,000 | (50%) |
| Interest Expense (fixed) | 90,000 | 90,000 | 0% | 30,000 | 30,000 | 0% |
| Net Income | 30,000 | (30,000) | (200%) | 30,000 | 0 | (100%) |
Concept Introduction:
Times Interest earned:
Times interest earned is used to assess the company's ability to meet its interest payment dues. The following formula is used to calculate the ratio.
Requirement 6:
The company having the greater ability to pay interest expenses if sales was to decrease
Answer to Problem 5BPSB
Seidel Company has the greater ability than Ellis Company to pay interest expense if sales were to decline.
Explanation of Solution
Computation of times Interest earned when sales decline by 20% and 50 % respectively for each company
| Ellis Company | Seidel Company | |||
| Decreased sales by 20% | Decreased sales by 50% | Decreased sales by 20% | Decreased sales by 50% | |
| Income before Interest | 96,000 | 60,000 | 48,000 | 30,000 |
| Interest Expense (fixed) | 90,000 | 90,000 | 30,000 | 30,000 |
| Times Interest Earned |
|
|
|
|
Hence, when sales decline by 20%, times interest earned of Ellis is 1.07 whereas that of Seidel Company is 1.6. When sales decline by 50%, times interest earned of Ellis is 0.67 whereas that of Seidel Company is 1
Hence, Seidel Company always has higher times interest earned when compared to Ellis Company when sales are decreasing. This is considering the fact that Ellis Company have high fixed interest burden of $90,000 whereas the obligation of Seidel Company is only $30,000
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