Company B has operating leases with a present value of $2,000 when future minimum lease payments are discounted at 9% as of 12/31/04. Times interest earned ratio, after necessary adjustments, for Company B is:
A) 10.26
B) 9.26
C) 6.56
D) 5.55

Question

Quizplus · Accepted Answer

To adjust for the operating lease, we need to add back the interest portion of the lease payments to the income before interest and taxes (EBIT) in the numerator, and add back the lease payments to the interest expense in the denominator. Since we are given only the present value of the leases, we need to use the annuity formula to calculate the annual lease payment: $2,000 = PMT * [(1 - 1/1.09^5)/0.09]. Solving for PMT, we get $452.69. The interest portion of the first year's lease payment would be $2,000 * 9% = $180. Therefore, the adjusted EBIT is $100 + $180 = $280, and the adjusted interest expense is $200 + $452.69 = $652.69. The TIE ratio is then $280 / $652.69 = 0.429, or 6.56 when expressed as a percentage.

Company B Has Operating Leases with a Present Value of $2,000