Question

Below is information for year ended 12/31/15 for Company A and Company B.

	Company A	Company B
Interest expense	$ 400	$ 0
Tax expense (40%)	400	400
Net income	600	600
Total assets	10,000	10,000
Total debt	5,000	0
Equity	5,000	10,000

Company A capitalized $100 in interest costs, the pension obligation, during the year. Times interest earned ratio, after necessary adjustments, for Company A is:

Group of answer choices

2.8

1.2

3.5

2.0

Answer 1

Times interest earned ratio = EBIT /Total Interest expense

Calculation of EBIT for Company A :-

Particulars	Amount
Net Income	600
Add- Tax expense	400
EBT	1,000
Add- Interest expense in p&l	400
EBIT	1,400

Interest capitalized should be included with the total interest expense in the denominator of the times interest earned ratio because it is part of the interest payment.

Total interest expense = interest expense in p&l + capitalized interest expense = 400 +100 = $ 500

Times interest earned ratio = EBIT / total interest expense = 1400 / 500

Times interest earned ratio = 2.8 times