Question

W.C. Pruett Corp. has $900,000 of interest-bearing debt outstanding, and it pays an annual interest rate of 12%. In addition, it has $700,000 of common stock on its balance sheet. It finances with only debt and common equity, so it has no preferred stock. Its annual sales are $4.86 million, its average tax rate is 30%, and its profit margin is 5%. What are its TIE ratio and its return on invested capital (ROIC)? Round your answers to two decimal places.

Answer 1

TIE ratio is computed as shown below:

= EBIT / Interest expense

EBIT is computed as follows:

= [ (Annual sales x profit margin) / (1 - tax rate) ] + Amount of debt x interest rate

= [ ($ 4,860,000 x 5%) / (1 - 0.30) ] + $ 900,000 x 12%

= $ 455,142.8571

So, the TIE ratio will be computed as follows:

= $ 455,142.8571 / ($ 900,000 x 12%)

= 4.21 Approximately

ROIC is computed as shown below:

= [ EBIT x (1 - tax rate) ] / (Amount of debt + common stock)

= [ $ 455,142.8571 x (1 - 0.30) ] / ($ 900,000 + $ 700,000)

= 19.91% Approximately

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