Question

Shree Bhawani is a wholesaler of Personal Protective Equipment. At the Beginning of the year 2020, H&S expanded its retail business by adding over shops in order to meet the demand for protective gear.

Total liabilities

R26 000  

R18 000  

Total shareholders' equity

34 000  

38 000  

Depreciation expense

R 2 000   

R 6 000   

Interest expense

3 400   

3 200   

Income tax expense

12 600   

18 100   

Net income / (profit)

6 000   

15 000   

Net cash provided by (used for) operations

41 000   

(400)  

Total dividends paid

2 000   

12 000   

Cash used to purchase plant assets

32 000   

18 000   

Payments on long-term debt

1 600   

1 800   

1)        Using the information provided above, calculate the following for 2019 and 2018:

            a. Debt-to-equity ratio (at each year-end)                                                (2)

            b. Times interests earned ratio                                                                  (2)

2)        Comment briefly on the company's solvency.                                        (4)

3)        What other ratios will help you assess the solvency?

Answer 1

1)

a) debt to equity = average Debt/average Equity = 22000/36000 = 0.61111

b) times interest earned = (net income+interest+taxes)/interest = (29150)/3300 = 8.83 times

2)

the times interest earned ratio is reasonably good because in the ideal condition having 2.5 times interest payment ratio is considered acceptable risk but here it is more than 4 so this company is reasonably solvent. company is having the debt to equity ratio of 0.61 which is also a reasonably good number because the owners have invested almost double amount than they have borrowed that means the business is much solvent because there is significant amount of owner is at stake as compared to borrowed amount.

3)

financial leverage is also a messure of solvency

salvency ratio

debt ratio

prpitory ratio

long term debt to equity ratio