A company's income before interest expense and income taxes in Year 1 and Year 2 is $225,000 and $250,000, respectively. Its interest expense was $45,000 for both years. Calculate the company's times interest earned ratio, and comment on its level of risk.
What will be an ideal response?
Year 1: 5.0
Year 2: 5.6
Risk analysis: The income before interest expense has increased, but the interest expense appears fixed. Consequently, the company's risk has decreased over the 2-year period. The company is improving on its ability to meet interest expense.
Times Interest Earned Ratio = Income before Interest Expense and Income Taxes/Interest Expense
Times Interest Earned Ratio = $225,000/$45,000 = 5.0 (Year 1)
Times Interest Earned Ratio = $250,000/$45,000 = 5.6 (Year 2)
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