Compute the times-interest-earned ratio

Leverage Ratios

Grammatico Company has just completed its third year of operations. The income statement is as follows:

Sales $ 2,460,000

Less: Cost of goods sold (1,410,000)

Gross profit margin $ 1,050,000

Less: Selling and administrative expenses (710,000)

Operating income $ 340,000

Less: Interest expense (140,000)

Income before taxes $ 200,000

Less: Income taxes (68,000)

Net income $ 132,000

Selected information from the balance sheet is as follows:

Current liabilities $1,000,000

Long-term liabilities 1,500,000

Total liabilities $2,500,000

Common stock $4,000,000

Retained earnings 750,000

Total equity $4,750,000

Required:

Note: Round answers to two decimal places.

1. Compute the times-interest-earned ratio.

2. Compute the debt ratio.

3. Conceptual Connection: Assume that the lower quartile, median, and upper quartile values for debt and times-interest-earned ratios in Grammatico’s industry are as follows:

Times – interest – earned: 2.4, 5.4, 16.1

Debt: 0.3, 0.8, 2.4

How does Grammatico compare with the industrial norms? Does it have too much debt?

Solution: