One way analysts measure the ability of a company to meet its obligations is to calculate the times interest earned ratio for any outstanding debt the company may have. How would a company with $100,000 of outstanding bonds paying 8.5% annually and income before interest and taxes of $50,000, calculate the interest coverage (accrual basis)ratio?
A)Income before interest and taxes divided by the interest expense.
B)Income before interest and taxes divided by carrying value of the bonds outstanding.
C)Income before interest and taxes divided by the face value on bonds.
D)Face value of the bonds divided by income before interest and taxes.

Question

Quizplus · Accepted Answer

The times interest earned (interest coverage) ratio can be calculated by dividing the company's income before interest and taxes by the interest expense. In this case, the interest expense is 8.5% of $100,000 or $8,500. Therefore, the interest coverage ratio would be $50,000/$8,500, which equals approximately 5.88. This means the company's income before interest and taxes is enough to cover the interest expense 5.88 times over.

One Way Analysts Measure the Ability of a Company to Meet