Page 696 - Accounting Principles (A Business Perspective)

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For Synotech, the net interest expense is USD 236.9 million. With an IBIT of USD 1,382.4 million, the times
interest earned ratio is 5.84, calculated as:
USD1,382.4 =5.84time
USD236.9
The company earned enough during the period to pay its interest expense almost 6 times over.
Low or negative interest coverage ratios suggest that the borrower could default on required interest payments.
A company is not likely to continue interest payments over many periods if it fails to earn enough income to cover
them. On the other hand, interest coverage of 5 to 10 times or more suggests that the company is not likely to

default on interest payments.
Times preferred dividends earned ratio Preferred stockholders, like bondholders, must usually be
satisfied with a fixed-dollar return on their investments. They are interested in the company's ability to make
preferred dividend payments each year. We can measure this ability by computing the times preferred
dividends earned ratio as follows:
Net income
Time preferred dividendsearned ratio=
Annual preferreddividends
Synotech has a net income of USD 762.0 million and preferred dividends of USD 25.7 million. The number of
times the annual preferred dividends are earned for 2010 is:
USD762.0 =29.65 :1 , or 29.65 times
USD 25.7
The higher this rate, the higher is the probability that the preferred stockholders will receive their dividends
each year.
Analysts compute certain ratios using information from the financial statements and information about the
market price of the company's stock. These tests help investors and potential investors assess the relative merits of
the various stocks in the marketplace.

The yield on a stock investment refers to either an earnings yield or a dividends yield.
Earnings yield on common stock You can calculate a company's earnings yield on common stock as
follows:
EPS
Earnings yield oncommon stock=
Current market price per shareof common stock
Assume Synotech has common stock with an EPS of USD 5.03 and that the quoted market price of the stock on
the New York Stock Exchange is USD 110.70. The earnings yield on common stock would be:
USD5.03
USD110.7 =4.54 percent
Price-earnings ratio When inverted, the earnings yield on common stock is the price-earnings ratio. To

compute the price-earnings ratio:
Current market price pershareof commonstock
Price−earnings ratio=
EPS
USD110.7 =22.01:1
USD5.03
Investors would say that this stock is selling at 22 times earnings, or at a multiple of 22. These investors might
have a specific multiple in mind that indicates whether the stock is underpriced or overpriced. Different investors
have different estimates of the proper price-earnings ratio for a given stock and also different estimates of the

Accounting Principles: A Business Perspective 697 A Global Text