What does the times interest earned ratio measure?

The times interest earned ratio is a key financial metric used to assess a company's ability to meet its debt obligations, specifically its interest payments. The correct formula for this ratio, which is the connection to choice C, involves adding net income, interest expense, and income tax expense, and then dividing that total by interest expense.

This approach provides a comprehensive view of a company's earnings relative to the total cost of its debt obligations. By including interest and tax expenses, it reflects how much cash flow is available to cover interest payments, demonstrating the company’s financial stability and ability to manage its debt load effectively. A higher times interest earned ratio indicates greater ability to fulfill interest obligations, suggesting lower financial risk.

In contrast, the other options do not adequately capture the relationship between income and interest expenses in terms of comprehensive financial health. Net income after taxes alone lacks the context of interest and tax effects, while net income divided by interest expense omits crucial elements that inform about the company’s cash flow and overall performance in covering interest costs. Operating income divided by interest expense, while informative, does not account for the income tax expense, which is critical for understanding the complete financial picture when assessing debt servicing capability.