Horace Corporation has $200,000 of convertible 5% bonds. Each 500 bond is convertible into 50 shares of common stock. The bonds were sold at par and are currently trading at par, and the required return on nonconvertible bonds of similar risk is 11%. Common stock is trading at 23 per share. Reported operating income for Horace Corporation was 145,000 and reported interest expense was 45,000. Times interest earned for Horace Corporation, after necessary adjustments, was: A. 2.22 B. 3.22 C. 4.22 D. 4.48 answer is © but I do not follow it. 200K*5% = 10K. So, EBIT + Int / Int = 145+10 / (45+10) = 2.82x. What am I missing? thank you
Interest coverage is not for a specific bond (as you add back in only that bond’s coupon payment), but the whole co (taking into account loans, bonds, any other interest bearing liabilities). Operating income (145) plus reported interest expense (45) is 190 divided by int exp (45). 190/45 = 4.22x. The bond is there as a distraction, unless it was trading in the money (convert) and you would want to back that interest expense out and treat it like equity. FYI, i am pretty sure on the calculation, but on the convert/backing out you may want to ask someone. It has been a while for me on accounting. Also, small note, you mention EBIT + Int. That is redundant. EBIT already has Interest expense backed out. Earnings Before Interest and Taxes.
I may have just muffed that up in a number of ways. I am glad I don’t have to do this manually all the time. Why would one add back in interest expense to operating income/EBIT when interest expense is below the operating income line? Id start with Net, add in D&A, T & I and end up with EBITDA/Interest (or some derivation thereof, EBIT, whatever). You shouldnt have to add anything to operating income because it hasnt been subtracted yet. Why have I confused myself so badly on something so simple? I feel really dumb now. Can I get an “amen”?
grover, thanks…it makes sense. Concerning the times interest earned, the official formula is (EBIT + I) / I. I asked a question about that today: http://www.analystforum.com/phorums/read.php?1,702250 many texts define as simply EBIT / I. I dont know why you add back interest though. I think it is correct though but not 100% sure.
pdvsa Wrote: ------------------------------------------------------- > grover, thanks…it makes sense. Concerning the > times interest earned, the official formula is > (EBIT + I) / I. I asked a question about that > today: > http://www.analystforum.com/phorums/read.php?1,702 > 250 > > many texts define as simply EBIT / I. I dont know > why you add back interest though. I think it is > correct though but not 100% sure. Where did you see (EBIT + I) / I? This is not logical. It makes no sense to add interest to earnings BEFORE interest, you would be adding interest back twice to EBT. I have never seen this formula. Times Interest Earned aka Interest Coverage Ratio: (EBT +I) / I = EBIT/I Also Operating Income is almost always definded as EBIT so I don’t understand why the answer adds back interest.