Problem:

A start-up company is seeking your advice concerning its debt ratio and capital structure decisions. It will require $1,000,000 of total assets and anticipates sales during its first year of operation to be $760,000. The sum of its operating costs and cost of goods sold will be $625,000. The company can borrow funds at an interest rate of 7.5% however, because of its high-risk business plan; the lender will require the firm to maintain a TIE (times-interest-earned) ratio of at least 5.5 xs.

Question: What is the maximum debt ratio the firm can use so as to meet its TIE ratio of 5.5x? (Note that by the term debt ratio I imply Debt/Total Assets from the 13th edition of our text, which in the 14th edition is called the Liabilities-to-assets ratio and is defined as Total liabilities/Total assets. Or assume account payable, accrual interest, and deferred taxes are all equal to zero).

Justify your answer, no word limits.