Net Income = 600 tax expense = 400 (40%) interest expense = 0 Company has operating leases with a present value of $2,000 when future minimum lease payments are discounted at 9%. Times interest earned ratio, after necessary adjustments, is: I GET D BUT THEY SAY ANS IS C. 1000 / (2000*9%) book says answer is C 6.56 A. 10.26 B. 9.26 C. 6.56 D. 5.55 How did they get 6.56x?
You forgot to add back the 180 to the numerator. The forumal is (1000 + (2000 * 9%))/(2000 * 9%) This give you 6.56
darn it. I remember now. So many texts fail to mention the add back in numerator. thank you
Why do you think there are more definitiions that fail to mention the add back of int in numerator? What is the significance of the add back. I get confused as to why there is an add back. Operating profit removes the interest but then you add it back in the numerator. This is confusing to me. Any thoughts on this? thank you
In this particular case the company already accounted for the lease as an operating lease, which means they took the entire lease payment as an expense thus lowering net income. Included in this “lease expense” was really $180 of interest expense…so to arrive at operating income (EBIT) you must add back interest to net income (along with taxes). This is only the case with operating leases. Now this assumes that under a capital lease Interest Expense + Depr Exp = Operating Lease Expense which will not be the case but it could be close. If you define times interest earned as EBITDA / I (as some texts do b/c depr is non-cash) this approach would work exactly.
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