QQuestionAccounting
QuestionAccounting
What does a times interest earned ratio of 10 times indicate?
Multiple choice question.
The firm can cover the fixed charges
10 times.
Income before interest and taxes covers the interest obligation of the firm by
10 times.
The firm can pay off the interest obligations every
10 days.
The firms debt is
10 times larger than the assets.
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Answer
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Step 1:: Understand the concept of the Times Interest Earned (TIE) ratio
The Times Interest Earned ratio, also known as the Interest Coverage Ratio, is a financial metric that shows a company's ability to pay its interest expenses on debt from its earnings before interest and taxes (EBIT). It is calculated by dividing EBIT by the interest expense.
Step 2:: Analyze the given ratio
A Times Interest Earned ratio of 10 indicates that the company's EBIT is 10 times larger than its interest expense.
Step 3:: Eliminate incorrect options
Option (c) "The firm can pay off the interest obligations every 10 days" is incorrect because the TIE ratio does not provide information on the time required to pay off interest obligations. Option (d) "The firm's debt is 10 times larger than the assets" is incorrect because the TIE ratio does not provide information about the company's debt or asset levels.
Step 4:: Evaluate the remaining options
Option (a) "The firm can cover the fixed charges 10 times" - While this option does not directly mention interest expenses, it implies that the company has a large EBIT relative to its fixed charges, which could include interest expenses. Option (b) "Income before interest and taxes covers the interest obligation of the firm by 10 times" - This option directly relates the EBIT (Income before interest and taxes) to the interest expense, which is the definition of the TIE ratio.
Step 5:: Select the most accurate answer
Comparing options (a) and (b), option (b) is more specific and directly related to the definition of the Times Interest Earned ratio. Therefore, the correct answer is: (b) Income before interest and taxes covers the interest obligation of the firm by 10 times.
Final Answer
Comparing options (a) and (b), option (b) is more specific and directly related to the definition of the Times Interest Earned ratio. Therefore, the correct answer is: (b) Income before interest and taxes covers the interest obligation of the firm by 10 times.
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