Question

Blackmun Corp signed a 3 year noncancelable lease for certain machinery on Dec 31, 2018. The terms of the lease called for Blackmun Corp to make equal annual payments of $15600 at the end of each year for 3 years, with title to pass to Blackmun Corp at the end of this period. The first payment is made one year after the lease is signed on Dec 31, 2018. The machinery has an estimated useful life of 3 years and no salvage value. Blackmun Corp uses the straight-line method of depreciation for all of its fixed assets. The effective interest rate for the lease was 6.6%.

Income Statement For: 2019
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Operating Income: 119,232
Earnings from affiliates: 0
Earnings Beore Interest and Taxes: 119,232
Interest expense: 4,950
Earnings before Taxes: 114,282
Provision for Taxes on Income: 31,999
Net income: 82,283
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The company had initially accounted for the lease as an operating lease and the figures above were produced using that assumption. Later the company decided to account for the lease as a capital lease. With the lease accounted for as a capital lease, the Times Interest Earned Ratio for 2019 is:

| Periods: Present value at 6.6% |
| 1: 0.9381 | | 2: 0.88 | | 3: 0.8255 | | 4: 0.7744 | | 5: 0.7265 |
| 6: 0.6815 | | 7: 0.6393 | | 8: 0.5997 |

| Periods: Present value Annuity at 6.6% |
| 1: 0.9381 | | 2: 1.8181 | | 3: 2.6436 | | 4: 3.418 | | 5: 4.1445 |
| 6: 4.826 | | 7: 5.4653 | | 8: 6.065 |

THE KEY PART OF THE QUESTION IS "The company had initially accounted for the lease as an operating lease and the figures above were produced using that assumption. Later the company decided to account for the lease as a capital lease. With the lease accounted for as a capital lease, the Times Interest Earned Ratio for 2019 is:"

Otherwise I believe the answer would simply be EBIT/Total Interest Expense or 119232 / 4950

		119232 / 7672
		119232 / 2722
		119232 / 4950
		132979 / 7672
		132979 / 2722
		132979 / 4950
		121085 / 7672
		121085 / 2722
		121085 / 4950

All information needed to solve has been provided

Answer 1

Present value annuity for 3 years is 2.6436

Annual lease rent is $15600

so, present value = $15600*2.6436 =$41240

Interest expense for the year = $41240*6.6% =$2722,

since earlier it was treated as operating lease then, $15600 was treated as lease rent. So, $15600 will be added back to profit.

Now as per capital lease, the depreciation on asset is charged, So depreciation amount will be $15600 ( as it has no salvage value). So rectified EBIT = 119232+15600-15600 =119232

Now, interest cost will be increased by $2722 So revised interest cost =$4950+2722 =7672

EBIT/Total Interest Expense =119232/7672 =15.54