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The following data were obtained from recent annual reports of Chevron, a multinational oil company (all data in $millions): 20x5 20x6 20x7 20x8 20x9 Interest

The following data were obtained from recent annual reports of Chevron, a multinational oil company (all data in $millions):

20x5 20x6 20x7 20x8 20x9

Interest expense............................ $ 401 $364 $312 $405 $472

Pretax income............................... 1,789 4,740 5,502 1,834 3,648

Net income................................... 930 2,607 3,256 1,339 2,070

Capitalized interest........................ 141 108 82 39 59

Amortization of capitalized interest... 47 24 28 35 9

  1. Using the reported interest expense, compute the interest coverage ratio for each year 20x5 to 20x9. The amortization of capitalized interest refers to the additional depreciation expense resulting from having a higher asset cost.
  2. Assuming that Chevron had always expensed interest as incurred:
    1. Recompute the interest coverage ratio for each year. Even though the revised EBIT would be slightly higher due to the amortization of capitalized interest, you may assume for this problem it is unchanged.
    2. Compare the two ratios (based on the reported versus restated data).
    3. Recompute income (assume a 35% marginal tax rate for interest each year; youll note this is different from the implied effective average rate from the above pretax income and net income numbers).
    4. Discuss the effect on net income of restatement to expense all interest.
  3. Discuss the effect of restatement on the five-year trend of Chevrons:
    1. Interest expense.
    2. Interest coverage ratio.
    3. Pretax income and net income.

State which calculation of the interest coverage ratio is better for financial analysis and justify your choice.

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