Long-Term Debt-Paying Ability: Arodex Co. Example
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Mr. Parks has asked you to advise him on the long-term debt-paying ability of Arodex Company. He provides you with the following ratios:
2007 2006 2005
Times interest earned: 8.2 6.0 5.5
Debt ratio: 40% 39% 40%
Debt to tangible net worth: 80% 81% 81%
a) Give the implications and the limitations of each item separately and then the collective influence that could be drawn from them about Arodex Company's long-term debt position.
b) What warnings should you offer Mr. Parks about the limitations of ratio analysis for the purpose stated here?
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Solution Summary
Solution provides implications and limitations, as well as warnings one should offer to Mr. Parks about these limitations.
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Times interest earned ratio denotes the number of times earnings before and taxes cover the interest amount payable by the company. In the present case, times interest earned ratio has been increasing from the year 2005 to 2007 which is the healthy sign. However, the limitation of this ratio is we cannot infer whether increase in times interest earned ratio is due to increase in EBIT or reduction in interest payment. Debt ratio denotes the proportion of debt of the company to total asset. The debt ratio of the company more or less ...
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