What effect will issuing more bonds typically have on the Times Interest Earned (TIE) ratio over time, assuming operating income remains constant?

• A. The TIE ratio will increase because operating income increases.
• B. The TIE ratio will decrease because interest expense increases.
• C. The TIE ratio will remain unchanged because bonds do not affect interest expense.
• D. The TIE ratio will increase because interest expense decreases.

Answer: (B)

Verified step by step guidance

1. Understand the Times Interest Earned (TIE) ratio formula: TIE = Operating Income / Interest Expense. This ratio measures a company's ability to cover its interest obligations with its operating income.
2. Analyze the impact of issuing more bonds: When a company issues more bonds, it typically incurs additional interest expense because bonds require periodic interest payments to bondholders.
3. Consider the assumption that operating income remains constant: Since operating income does not change, the numerator of the TIE ratio remains the same.
4. Evaluate the effect of increased interest expense: As interest expense increases due to the issuance of more bonds, the denominator of the TIE ratio increases, leading to a decrease in the overall TIE ratio.
5. Conclude that the TIE ratio will decrease over time if operating income remains constant and interest expense increases due to issuing more bonds.