C10-1 Calculating Interest and Depreciation Expenses and Effects on Loan Covenant Ratios Zoom Car Corporation (ZCC) plans to purchase approximately 100 vehicles on December 31, 2015, for $2.3 million, plus 10 percent total sales tax. ZCC expects to use the vehicles for 5 years and then sell them for approximately $460,000. ZCC anticipates the following average vehicle use over each year ended December 31: 2016 2017 20,000 2018 2019 2020 Miles per year 14,500 15,000 14,500 5,000 To finance the purchase, ZCC signed a 5-year promissory note on December 31, 2015, for $2.07 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, ignore income tax.) (in 000s) Sales Revenue 2016 $ 2,300 1,150 2017 $ 2,800 1,350 2018 2019 2020 $ 3,300 1,750 $ 3,100 1,550 $ 3,200 1,650 Income before Depreciation and Interest Expense Required: 1. Calculate the amount of interest expense that would be recorded each year. Interest Expense $ 124,200 per year 2. Calculate the depreciation expense that would be recorded each year, using the following depreciation methods: (a) Straight-line Straight-line Depreciation per year (b) Double-declining-balance (Do not round intermediate calculations.) Depreciation Expense 2016 2017 2018 2019 2020 (c) Units-of-production Depreciation Expense 2016 2017 2018 2019 2020 3. Using your answers to requirements 1 and 2, determine net income and the two loan covenant ratios in each year, assuming the company chooses the following depreciation methods: (a) Straight-line (Enter your answers for Net Income in thousands (i.e., 50,500 should be entered as 50.5). Round "Net Income" to 1 decimal place and "Ratio Values" to 2 decimal places.) Worksheet 2016 2017 2018 2019 2020 Net Income Times Interest Earned Ratio Fixed Asset Turnover Ratio (b) Double-declining-balance (Enter your answers for Net Income in thousands (i.e., 50,500 should be entered as 50.5). Round "Net Income" to 1 decimal place and "Ratio Values" to 2 decimal places.) 2016 2018 2019 2017 2020 Net Income Times Interest Earned Ratio Fixed Asset Turnover Ratio (c) Units-of-production (Enter your answers for Net Income in thousands (i.e., 50,500 should be entered as 50.5). Round "Net Income" to 1 decimal place and "Ratio Values" to 2 decimal places.) 2016 2017 2018 2019 2020 Net Income Times Interest Earned Ratio Fixed Asset Turnover Ratio 4. Using your answers to requirement 3, indicate whether the loan covenants would be violated under the following depreciation methods: Depreciation Methods Violated Loan Covenants Straight-line Double-declining-balance Units-of-production a C
