What does a Times Interest Earned (TIE) ratio of 10 times indicate?

• A. The company earns enough operating income to cover its interest expense 10 times over.
• B. The company has 10 times more debt than equity.
• C. The company can only pay 10% of its interest obligations.
• D. The company pays 10% of its income in interest expenses.

Answer: (A)

Verified step by step guidance

1. Understand the Times Interest Earned (TIE) ratio: The TIE ratio measures a company's ability to meet its interest obligations using its operating income. It is calculated as: $\frac{\mathrm{Operating Income}}{\mathrm{Interest Expense}}$.
2. Interpret the TIE ratio value: A TIE ratio of 10 means that the company's operating income is 10 times greater than its interest expense.
3. Analyze the implications: This indicates that the company generates sufficient operating income to cover its interest obligations comfortably, reducing the risk of default on interest payments.
4. Eliminate incorrect interpretations: The TIE ratio does not measure the proportion of debt to equity, nor does it indicate the percentage of income spent on interest. It specifically reflects the company's ability to cover interest expenses with operating income.
5. Conclude: A TIE ratio of 10 times indicates that the company earns enough operating income to cover its interest expense 10 times over, demonstrating strong financial health in terms of interest coverage.