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 5.5x.

Question: What is the maximum debt ratio the firm can use so as to meet its TIE ratio of 5.5x? Please explain in detail and show your work.