A problem with the Times Interest Earned (TIE) ratio is that it is based on:

• A. Market value of equity, which fluctuates with stock prices
• B. Earnings before interest and taxes (EBIT), which does not reflect actual cash flows available to pay interest
• C. Total assets, which may not be related to interest payments
• D. Net income, which includes non-operating items

Answer: (B)

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. It is calculated as Earnings Before Interest and Taxes (EBIT) divided by interest expense.
2. Recognize the limitation of using EBIT: EBIT is an accounting measure that does not represent actual cash flows. It excludes non-cash items like depreciation and amortization, which can affect the company's ability to pay interest.
3. Identify the issue with net income: Net income includes non-operating items such as gains or losses from investments, which may not be related to the company's core operations or ability to pay interest.
4. Understand why market value of equity is irrelevant: The market value of equity fluctuates with stock prices and does not directly relate to the company's ability to meet interest payments.
5. Consider the irrelevance of total assets: Total assets represent the company's resources but do not directly indicate its ability to generate cash flows for interest payments.