Question

The following financial information was obtained from the year ended 2018 income statements for Cash Automotive and Pennington Automotive:

Cash Pennington

Net income \( 26,070 \) 74,188

Income tax expense 9,270 27,080

Interest expense 300 2,900

Requirements

1. Compute the times-interest-earned ratio for each company. Round to two decimals.

2. Which company was better able to cover its interest expense?

Short answer

Times Interest Earned Ratio

For Cash Automotive: 119 times

For Pennington Automotive: 35.92 times

Step-by-step solution

Computation of times interest earned ratio

$$\begin{gathered} \mathbf{For}\mathbf{}\mathbf{cash}\mathbf{}\mathbf{Automative}\mathbf{}\mathbf{Co}\mathbf{.}\mathbf{=}\mathbf{}\frac{\mathbf{Net}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{+}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{Tax}\mathbf{}\mathbf{Expense}\mathbf{}\mathbf{+}\mathbf{}\mathbf{Interest}\mathbf{}\mathbf{Expense}}{\mathbf{Interest}\mathbf{}\mathbf{Expense}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\mathbf{\$}\mathbf{26}\mathbf{,}\mathbf{070}\mathbf{+}\mathbf{\$}\mathbf{9}\mathbf{,}\mathbf{270}\mathbf{+}\mathbf{\$}\mathbf{300}}{\mathbf{\$}\mathbf{300}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{119}\mathbf{times} \\ \mathbf{For}\mathbf{}\mathbf{Peninngton}\mathbf{}\mathbf{Automative}\mathbf{}\mathbf{Co}\mathbf{.}\mathbf{=}\mathbf{}\frac{\mathbf{Net}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{+}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{Tax}\mathbf{}\mathbf{Expense}\mathbf{}\mathbf{+}\mathbf{}\mathbf{Interest}\mathbf{}\mathbf{Expense}}{\mathbf{Interest}\mathbf{}\mathbf{Expense}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\mathbf{\$}\mathbf{74}\mathbf{,}\mathbf{188}\mathbf{+}\mathbf{\$}\mathbf{27}\mathbf{,}\mathbf{080}\mathbf{+}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{900}}{\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{900}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{}\mathbf{35}\mathbf{.}\mathbf{92}\mathbf{times}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{} \end{gathered}$$

Conclusion

Based on the above-computed ratio, Cash Automotive is better enough to cover its interest expense as the income before interest and tax is 119 times more than the Pennington Automotive.