Computing debt ratio and times-interest-earned


1) The Company plans to increase a net amount of =$270 million to finance new equipment and working capital in early 2002. 2 alternatives are being considered: Common stock may be sold to net $60 per share, or bonds yielding= 12 percent may be issued. The balance sheet and income statement of the Company prior to financing are as follows:

The Company: Balance Sheet as of December 31, 2001 (Millions of Dollars)
Present assets= $ 900.00 Accounts payable= $ 172.50 Net fixed assets450.00 Notes payable to bank255.00

Other current liabilitie s225.00
Total current liabilities$ 652.50
Long-term debt (10%)300.00
Common stock, $3 par60.00
Retained earnings337.50

Total assets$1,350.00Total liabilities and equity$1,350.00

The Company: Income Statement for Year Ended December 31, 2001(Millions of Dollars) sales$2,475.00
Operating costs= 2, 227.50 Earnings before interest and taxes (10%) $ 247.50 Interest on short-term debt= 15.00 Interest on long-term debt30.00 Earnings before taxes$ 202.50 Federal-plus-state taxes (40%)81.00 Net income= $ 121.50. The probability distribution for annual sales is as follows:

ANNUAL SALES PROBABILITY(MILLIONS OF DOLLARS)

0.30    $2,2500
.40    2,7000
.30    3,150

Supposing that EBIT is equal to 10% of sales, compute earnings per share under both debt financing and stock financing alternatives at each possible level of sales. Then compute expected earnings per share and EPS under both debt and stock financing alternatives.

Also, compute debt ratio and times-interest-earned (TIE) ratio at expected sales level under each alternative. Old debt will remain out-standing.

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Finance Basics: Computing debt ratio and times-interest-earned
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