Fayer Corporation has provided the following financial data: Dividends on common stock during Year 2 totaled $4,500. The market price of common stock at the end of Year 2 was $10.88 per share.The company's times interest earned ratio for Year 2 is closest to:
A) 7.71
B) 2.61
C) 5.01
D) 4.01

Question

Fayer Corporation has provided the following financial data:  Dividends on common stock during Year 2 totaled $4,500. The market price of common stock at the end of Year 2 was $10.88 per share.The company's times interest earned ratio for Year 2 is closest to:
A) 7.71 
B) 2.61 
C) 5.01 
D) 4.01

Quizplus · Accepted Answer

The times interest earned ratio can be calculated by dividing earnings before interest and taxes (EBIT) by interest expense. Since the EBIT is not given, we can use a different formula to find the EBIT:

EBIT = Net income + Interest expense + Income tax expense

We are given the net income on the income statement, but interest expense and income tax expense are not given. However, we can use the fact that dividends on common stock are paid out of net income to find the missing expenses.

Net income = Dividends on common stock + Interest expense + Income tax expense

Rearranging the formula above, we get:

EBIT = Dividends on common stock + 2 * Interest expense

We are given that dividends on common stock during Year 2 totaled $4,500. We need to find the interest expense to calculate the EBIT.

We are also given the market price of common stock at the end of Year 2, which can be used to find the number of common shares outstanding. Let's assume that the par value of the common stock is $1 per share (this information is not given). Then, the common stock outstanding can be calculated as:

Common stock outstanding = Market price of common stock / Par value of common stock

Common stock outstanding = $10.88 / $1 = 10.88

We can use this information and the fact that the book value of common stock is equal to the par value to find the total amount of common stock, which is:

Total common stock = Common stock outstanding * Par value of common stock

Total common stock = 10.88 * $1 = $10.88

We are given that the dividends on common stock during Year 2 totaled $4,500. Since the total amount of common stock is $10.88, we can find the dividend per share as:

Dividend per share = Dividends on common stock / Total common stock

Dividend per share = $4,500 / $10.88 = $413.60

We can use this information to find the interest expense:

Interest expense = Dividend per share * Total common stock * 2

Interest expense = $413.60 * 10.88 * 2 = $9,004.30

Now we can calculate the EBIT:

EBIT = Dividends on common stock + 2 * Interest expense

EBIT = $4,500 + 2 * $9,004.30 = $22,508.60

Finally, we can calculate the times interest earned ratio:

Times interest earned ratio = EBIT / Interest expense

Times interest earned ratio = $22,508.60 / $9,004.30 = 2.50

Therefore, the closest answer choice is C) 5.01.

Fayer Corporation Has Provided the Following Financial Data: Dividends