CS Executive · Corporate Accounting and Financial Management · Financial Statement Analysis
Profit before interest and tax of a company is ₹9,00,000 and it pays interest of ₹3,00,000 on its debentures. Tax rate is 30%. What is its interest coverage ratio, and what happens to it if interest rises to ₹4,50,000 with the same PBIT?
Interest coverage is 3 times, falling to 2 times when interest rises to ₹4,50,000. The ratio is PBIT divided by interest, so tax does not enter. Using profit after tax in the numerator is the usual error and gives wrong figures.
- A3 times, falling to 2 timesCorrect
- B3 times, falling to 1.5 times
- C2 times, falling to 1.33 times
- D4.2 times, falling to 2.8 times
Explanation
Interest coverage = PBIT / interest = 9,00,000/3,00,000 = 3 times. With interest 4,50,000 it is 9,00,000/4,50,000 = 2 times. Tax is irrelevant to the ratio; option 4.2 and 2.8 use post-tax profit of 6,30,000 wrongly with PBIT-type numerators.
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