Question

The Morrit Corporation has $600,000 of debt outstanding, and it pays an interest rate of 8%

annually. Morrit’s annual sales are $3 million, its average tax rate is 25%, and its net profit

margin on sales is 3%. If the company does not maintain a TIE ratio of at least 5 to 1, then

its bank will refuse to renew the loan, and bankruptcy will result. What is Morrit’s TIE ratio?

Answer #1

Solution :-

Interest = Debt * Intt Rate = $600,000 * 8% = $48,000

Net Income = Sales * Net Profit Margin = $3,000,000 * 3% = $90,000

Pre tax Income = Net Income / ( 1 - tax rate ) = $90,000 / ( 1 - 0.25 ) = $120,000

EBIT = Pre tax Income + Interest = $120,000 + $48,000 = $168,000

Now Morrit’s TIE ratio = EBIT / Interest exps = $168,000 /
$48,000 **= 3.5 times**

As TIE Ratio is not greater than or equal to 5

So Loan will not be renewed and they will go bankrupt

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