A company with no interest-bearing debt enters into a capital lease on the 1st day of the reporting year. The lease requires a year-end payment of $175,000 for 10 years. In the 2nd year of the lease, the company reported EBIT of $450,000. Assuming a 7% imputed interest reate on the lease, the firm’s interest coverage ratio in the 2nd year is closest to: a. 4.3x b. 5.1x c.5.6x d. 6.7x The answer is c. 5.6x. Here’s the explaination: The PV of a lease payment with one annual payment of $175,000 at the end of the year over a 10-yr period, discounted at 7% is $1,229,127. ( ??? I can’t figure out how they get this number. What I got is 175/(1.07^10)=88.96113) EOP Balance=1229127*1.07-175000=1140166 int during the 2nd yr of the lease=1140166*.07=79812 int coverage=EBIT/int=450000/79812=5.64x
N =10 PMT= -175,000 I = 7% lower of the 2 rates compute PV = $1,229,127!
To save some time just use N=9, this will account for all action is the first year and get you 2nd year PV. Then you can just multiply this calculated PV by .07 to get interest. Then do your interest coverage calculation.
Ah…so 175000 is the annual payment. I thought it was the lump sum payment in the end. That’s why I calculated wrong! Good point, javanon860! That does save some time! Thank you, guys!