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Maximum Debt Ratio of a Start-Up

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A start-up company is seeking your advice concerning its debt ratio and capital structure decisions. It will require $1,000,000 of total assets and anticipates sales during its first year of operation to be $650,000. The sum of its operating costs and cost of goods sold will be $525,000.The company can borrow funds at an interest rate of 8% however, because of its high-risk business plan, the lender will require the firm to maintain a TIE (times-interest-earned) ratio of at least 5.0x. What is the maximum debt ratio the firm can use so as to meet its TIE ratio of 5.0x? Note that by the term debt ratio I imply Debt/Total Assets from the 13th edition of our text, which in the 14th edition is called the Liabilities-to-assets ratio and is defined as Total liabilities/Total assets.

Hint: To determine the annual interest paid, use the following: INT($) = Debt xi
(wherei = interest rate in %). Also, EBIT = Sales - Operating costs - Cost of goods sold.

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EBIT = $650,000 - $525,000 = $125,000

TiE ratio needs to be at ...

Solution Summary

The solution solves the question and determines the maximum debt ratio of the company. All the steps are clearly explained and defined in the solution.