The W.C. Pruett Corp. has $200,000 of interest-bearing debt outstanding, and it pays an annual interest rate of 11%. In addition, it has $700,000 of common stock on its balance sheet. It finances with only debt and common equity, so it has no preferred stock. Its annual sales are $1 million, its average tax rate is 35%, and its profit margin is 8%. What are its TIE ratio and its return on invested capital (ROIC)? Round your answers to two decimal places.

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amcool amcool · Answer 1 · 2020-06-15T04:58:52+02:00

Answer:

a. Times Interest Earned (TIE) Ratio = 6.59 times

b. Return on invested capital (ROIC) = 10.48%

Explanation:

To estimate these, we have to first calculate the following:

Interest expenses = $200,000 * 11% = $22,000

Net income = Profit margin * Annual sales = 8% * $1,000,000 = $80,000

Income before tax = Net income / (1 - Average tax rate) = $80,000 / (1 - 35%) = 123,076.92

Tax = Income before tax * Tax rate = $123,076.92 * 35% = $43,076.92

Earning before interest and tax (EBIT) = Net income + Interest expenses + Tax = $80,000 + $22,000 + $43,076.92 = $145,076.92

Net operating profit after tax (NOPAT) = EBIT * (1 - Average tax rate) = $145,076.92 * (1 - 35%) = $94,300

Invested capital = Common stock + Interest-bearing debt outstanding = $200,000 + $700,000 = $900,000

a. What are its TIE ratio?

Times Interest Earned (TIE) Ratio = EBIT / Interest expenses = $145,076.92 / $22,000 = 6.59 times

This indicates that the income of the W.C. Pruett Corp. is 6.59 times greater than its annual interest expense.

b. What are its return on invested capital (ROIC)?

ROIC = NOPAT / Invested capital = $94,300 / $900,000 = 0.1048, or 10.48%