ANALYSIS FOR FINANCIAL MANAGEMENT

10TH Edition
Robert C. Higgins
Suggested Answers to Additional Problems
Chapter 6
1) a. and b.
Baltimore Beverages Company
($ millions)
EBIT (aka, operating profit)

10.35 $

15.41 $

16.95 $

18.65 $

20.51 $

22.56

Interest expense

5.33

5.82

5.81

5.76

5.66

5.52

Times interest earned

1.94

2.65

2.92

3.24

3.62

4.09

% EBIT can fall

0.48

0.62

0.66

0.69

0.72

0.76

c. According to Table 6.5 in the text, companies with BB rated debt had a median coverage ratio of 3.5
times, while B rated debt had a coverage ratio of 1.4 times. This suggests that Baltimore Beverages
1.94 coverage ratio in 2010 would earn a BB or BB- debt rating.
d. With a coverage ratio of 1.94, significantly increasing financial leverage would be quite aggressive,
putting the companys debt well into the speculative, or junk, categories.
2) a. EBIT = [40/(1 0.36)]+15 = $77.5.
Interest = $15 + 0.07(40) = $17.8. Times-interest-earned = 77.5/17.8 = 4.35 times.
b. Burden of interest and sinking fund before tax = 17.8 + (14 + 8)/(1- 0.36) = $52.17.
Times burden covered = 77.5/52.18 = 1.49 times
c. EPS = (77.5 17.8)(1 0.36)/18 = $2.12.
d. Times interest earned = 77.5/15 = 5.17 times. Times burden covered = 77.5/[15 + 14/(1 0.36)] =
2.10 times. EPS = (77.5 15)(1 0.36)/(18 + 2) = $2.00.
3) EPS with new debt financing equals (EBIT 50 [0.14*150])(1-0.34)/80. EPS with new equity
financing equals (EBIT 50)(1-0.34)/95. Setting the two equations equal and solving for EBIT we get
the breakeven EBIT equal to $183 million.