Explanation:
To determine whether solvency has improved or deteriorated, we need to calculate the Year 2 ratios and compare them with Year 1 ratios.
Step 1: Calculate Year 2 Debt to Capital ratio
Debt to Capital = Total Debt / (Total Debt + Total Shareholders' Equity)
Year 2:
Debt to Capital = 2,300 / 19,300 = 0.1192 or 11.92%
Step 2: Calculate Year 2 Interest Coverage ratio
Interest Coverage = (Net Income + Interest Expense + Taxes) / Interest Expense
Year 2:
EBIT = Net Income + Interest Expense + Taxes = 375 + 200 + 125 = ¥700 million
Interest Coverage = 700 / 200 = 3.5
Step 3: Compare Year 2 ratios with Year 1 ratios
Year 1 Ratios:
Year 2 Ratios:
Analysis:
Both solvency ratios have strengthened in Year 2 compared to Year 1:
Therefore, the company's solvency has improved.
Ultimate access to all questions.
An analyst is comparing the solvency of a company over the past two years using the information below:
| Year 2 | ¥ Millions |
|---|---|
| Total debt | 2,300 |
| Total shareholders' equity | 17,000 |
| Total assets | 20,000 |
| Net income | 375 |
| Interest payments/interest expense | 200 |
| Taxes paid | 125 |
Ratios in Year 1
| Ratios in Year 1 | Ratios |
|---|---|
| Debt to capital | 12.7% |
| Interest coverage | 2.9 |
The best conclusion the analyst can make about Year 2 is that compared with Year 1, the company's solvency has:
A
remained the same.
B
deteriorated because both ratios have weakened.
C
improved because both ratios have strengthened.
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