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Times interest earned:
Times interest earned measures whether the company is in position to pay its debt obligations or not. It is also known as Interest Coverage Ratio.
1.
To compute: Times interest earned of E company.
Explanation of Solution
Given,
For E company
Income before interest is $120,000.
Interest expense is $90,000.
Times interest earned
Formula to calculate times interest earned,
Substitute $120,000 for income before interest and tax and $90,000 for interest expense.
Thus, times interest earned of E company is 1.33 times.
2.
To compute: Times interest earned of S company.
2.
Explanation of Solution
Given,
For S company
Income before interest is $60,000.
Interest expense is $30,000.
Times interest earned
Formula to calculate times interest earned,
Substitute $60,000 for income before interest and tax and $30,000 for interest expense.
Thus, times interest earned of S company is 2 times.
3.
To compute: Net income if sales increase by 10%.
3.
Explanation of Solution
Net income if sales increase by 10%.
| Particulars | E Company ($)(given) | E Company ($)(10% increased sales) | S Company ($)(given) | S Company ($)(10% increased sales) |
| Sales | 240,000 | 264,000 | 240,000 | 264,000 |
| Variable expenses | 120,000 | 132,000 | 180,000 | 198,000 |
| Income before interest | 120,000 | 132,000 | 60,000 | 66,000 |
| Interest expense | 90,000 | 90,000 | 30,000 | 30,000 |
| Net Income | 30,000 | 42,000 | 30,000 | 36,000 |
| Increase in net income | 40% | 20% |
Table (1)
Working note:
Formula to calculate percentage increase in net income is,
For Company E
For Company S
Thus, net income of company E gets increased by 40% and company S by 20%.
4.
To compute: Net income if sales increase by 40%.
4.
Explanation of Solution
Net income if sales increase by 40%.
| Particulars | E Company ($)(given) | E Company ($)(40% increased sales) | S Company ($)(given) | S Company ($)(40% increased sales) |
| Sales | 240,000 | 336,000 | 240,000 | 336,000 |
| Variable expenses | 120,000 | 168,000 | 180,000 | 252,000 |
| Income before interest | 120,000 | 168,000 | 60,000 | 84,000 |
| Interest expense | 90,000 | 90,000 | 30,000 | 30,000 |
| Net Income | 30,000 | 78,000 | 30,000 | 54,000 |
| Increase in net income | 160% | 80% |
Table (1)
Working Note:
Formula to calculate percentage increase in net income is,
For Company E
For Company S
Thus, net income of company E gets increased by 160% and company S by 80%.
5.
To compute: Net income if sales increase by 90%.
5.
Explanation of Solution
Net income if sales increase by 90%.
| Particulars | E Company ($)(given) | E Company ($)(90% increased sales) | S Company ($)(given) | S Company ($)(90% increased sales) |
| Sales | 240,000 | 456,000 | 240,000 | 456,000 |
| Variable expenses | 120,000 | 228,000 | 180,000 | 342,000 |
| Income before interest | 120,000 | 228,000 | 60,000 | 114,000 |
| Interest expense | 90,000 | 90,000 | 30,000 | 30,000 |
| Net Income | 30,000 | 138,000 | 30,000 | 84,000 |
| Increase in net income | 360% | 180% |
Table (1)
Working note:
Formula to calculate percentage increase in net income is,
For Company E
For Company S
Thus, net income of company E gets increased by 360% and company S by 180%.
6.
To compute: Net income if sales decrease by 20%.
6.
Explanation of Solution
Net income if sales decrease by 20%.
| Particulars | M Company ($)(given) | M Company ($)(20% decreased sales) | S Company ($)(given) | W Company ($)(20% decreased sales) |
| Sales | 240,000 | 192,000 | 240,000 | 192,000 |
| Variable expenses | 120,000 | 96,000 | 180,000 | 144,000 |
| Income before interest | 120,000 | 96,000 | 60,000 | 48,000 |
| Interest expense | 90,000 | 90,000 | 30,000 | 30,000 |
| Net Income | 30,000 | 6,000 | 30,000 | 18,000 |
| Increase in net income | -80% | -40% |
Table (1)
Working note:
Formula to calculate percentage increase in net income is,
For Company E
For Company S
Thus, Net Income of company E gets decreased 80% and company S by 40%.
7.
To compute: Net income if sales decrease by 50%.
7.
Explanation of Solution
Net income if sales decrease by 50%.
| Particulars | E Company ($)(given) | E Company ($)(50% decreased sales) | S Company ($)(given) | S Company ($)(50% decreased sales) |
| Sales | 240,000 | 120,000 | 240,000 | 120,000 |
| Variable expenses | 120,000 | 60,000 | 180,000 | 90,000 |
| Income before interest | 120,000 | 60,000 | 60,000 | 30,000 |
| Interest expense | 90,000 | 90,000 | 30,000 | 30,000 |
| Net Income | 30,000 | (30,000) | 30,000 | 0 |
| Increase in net income | -200% | -100% |
Table (1)
Working Note:
Formula to calculate percentage increase in net income is,
For Company E
For Company S
Thus, Net Income of company E gets decreased 200% and company S by 100%.
8.
To compute: Net income if sales decrease by 80%.
8.
Explanation of Solution
Net income if sales decrease by 80%.
| Particulars | E Company ($)(given) | E Company ($)(80% decreased sales) | S Company ($)(given) | S Company ($)(80% decreased sales) |
| Sales | 240,000 | 48,000 | 240,000 | 48,000 |
| Variable expenses | 120,000 | 24,000 | 180,000 | 36,000 |
| Income before interest | 120,000 | 24,000 | 60,000 | 12,000 |
| Interest expense | 90,000 | 90,000 | 30,000 | 30,000 |
| Net Income | 30,000 | (66,000) | 30,000 | (18,000) |
| Increase in net income | -320% | -160% |
Table (1)
Working note:
Formula to calculate percentage increase in net income is,
For Company E
For Company S
Thus, Net Income of company E gets decreased 320% and company S by 160%.
9.
Relation to fixed cost strategies of the two companies
9.
Explanation of Solution
Relation to fixed cost strategies of the two companies
- Here in this case fixed cost refers to interest expenses.
- Interest expenses in company E are $ 90,000 and in company S are $30,000. Interest expenses are higher in company E than in company S
- Due to higher interest expenses, change in net income gets more effected due to change in sales.
- Higher fixed cost is inversely related to times interest earned method.
- So if sales get increased, E company enjoys higher percent increase in income in comparison to company S
- If sales get decreased, S company experiences smaller percent change in net income in comparison to company E.
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