15 OS2 052 points C101 Calculating Interest and Depreciation

15. OS2 0.52 points C10-1 Calculating Interest and Depreciation Expenses and Effects on Loan Covenant Ratios (Chapters 9 and 10) [LO 9-3, LO 9-7, LO 10-2, LO 10-5 Zoom Car Corporation (ZCC) plans to purchase approximately 100 vehicles on December 31, 2015, for $17 mlon, plus 10 percent total sales tax. ZCC expects to use the vehicles for 5 years and then sell them for approximately $340,000. ZCC anticipates the following average vehicle use over each year ended December 31 2016 15,000 2019 5,500 2020 5,000 Miles per year 20,000 5,500 To finance the purchase, ZCC signed a 5-year promissory note on December 31, 2015, for $1.53 million, with interest paid annually at the market interest rate of 6 percent. The note carries loan covenants that require ZCC to maintain a minimum times interest earned ratio of 3.0 and a minimum fixed asset turnover ratio of 1.0. ZCC forecasts that the company will generate the following sales and preliminary earnings (prior to recording depreciation on the vehicles and interest on the note). (For purposes of this question, gnore income tax.) 2016 2017 2018 2019 2020 $1,700 $ 2,200 $2,500 $2,600 $2,700 850 1,050 1,250 1,350 1,450 (in 000s) Sales Revenue Income before Depreciation and Interest Expense

Solution

Ans 1 Interest expense 1.53 million*6%=$91800 2(a) As per Straight Line Method Cost=$17000000+17000000*10%=$1870000, Hence Depreciaciation = ( ($1870000-$340000)/5)=$306000 Book Value $1,870,000 2016 $306,000 $1,564,000 2017 $306,000 $1,258,000 2018 $306,000 $952,000 2019 $306,000 $646,000 2020 $306,000 $340,000 Total $1,530,000 2(b) Double declining method Depreciation method=Double Declining method 200%*Straight Line Depreciation Rate* book value at the beginning of year Hence Rate for Double Decline ( 2*20%)=40% Year Net Book Value at beginning Depreciation Expense Book Value at End 2016 $1,870,000 $748,000 $1,122,000 2017 $1,122,000 $448,800 $673,200 2018 $673,200 $269,280 $403,920 2019 $403,920 $161,568 $242,352 2020 $242,352 $96,941 $145,411 Total $1,724,589 2(c) Unit of Activity Method Depreciation=(Cost-Salvage value)* Actual Mile/Total Expected Mile Year Book Value at beginning Depreciation Book Value at End Calculation 2016 $1,870,000 $450,000 $1,420,000 ((1870000-$340000)X 15/51) 2017 $1,420,000 $423,529 $996,471 ((1870000-$340000)X 20/51) 2018 $996,471 $70,796 $925,675 ((1870000-$340000)X 5.5/51) 2019 $925,675 $63,161 $862,514 ((1870000-$340000)X 5.5/51) 2020 $862,514 $51,227 $811,287 ((1870000-$340000)X 5/51) 3(a) straight Line Method Sales Revenue $1,700,000 $2,200,000 $2,500,000 $2,600,000 $2,700,000 Income Before Depreciation and Interest $850,000 $1,050,000 $1,250,000 $1,350,000 $1,450,000 Less: Interest expense $91,800 $91,800 $91,800 $91,800 $91,800 Less: depreciation $306,000 $374,000 $374,000 $374,000 $374,000 Net Income $452,200 $584,200 $784,200 $884,200 $984,200 Times Interest earned Ratio Income Before Depreciation and Interest/Interest expense                             9.26                            11.44                  13.62                             14.71                 15.80 Fixed asset turnover ratio Sales/Fixed Assets 1.09 1.75 2.63 4.02 7.94 Fixed Assets (Book Value) $1,564,000 $1,258,000 $952,000 $646,000 $340,000 3(b)Double declining Method Sales Revenue $1,700,000 $2,200,000 $2,500,000 $2,600,000 $2,700,000 Income Before Depreciation and Interest $850,000 $1,050,000 $1,250,000 $1,350,000 $1,450,000 Less: Interest expense $91,800 $91,800 $91,800 $91,800 $91,800 Less: depreciation $748,000 $448,800 $269,280 $161,568 $96,941 Net Income $10,200 $509,400 $888,920 $1,096,632 $1,261,259 Times Interest earned Ratio Income Before Depreciation and Interest/Interest expense                             9.26                            11.44                  13.62                             14.71                 15.80 Fixed asset turnover ratio Sales/Fixed Assets                             1.52                               3.27                     6.19                             10.73                 18.57 Fixed Assets (Book Value) $1,122,000 $673,200 $403,920 $242,352 $145,411 Unit of Production method Sales Revenue $1,700,000 $2,200,000 $2,500,000 $2,600,000 $2,700,000 Income Before Depreciation and Interest $850,000 $1,050,000 $1,250,000 $1,350,000 $1,450,000 Less: Interest expense $91,800 $91,800 $91,800 $91,800 $91,800 Less: depreciation $450,000 $423,529 $70,796 $63,161 $51,227 Net Income $308,200 $534,671 $1,087,404 $1,195,039 $1,306,973 Times Interest earned Ratio Income Before Depreciation and Interest/Interest expense                             9.26                            11.44                  13.62                             14.71                 15.80 Fixed asset turnover ratio Sales/Fixed Assets                             1.20                               2.21                     2.70                               3.01                   3.33 Fixed Assets (Book Value) $1,420,000 $996,471 $925,675 $862,514 $811,287