Question
Download Solution PDFNet profit after taxes of a firm is Rs.1,00,000 and its fixed interest charges on long term debt are Rs. 20,000. What is the interest coverage ratio if the rate of income tax is 60%?
Answer (Detailed Solution Below)
Detailed Solution
Download Solution PDFThe correct answer is 13.5 times.
Key Points To calculate the interest coverage ratio, we need to determine the earnings available to cover the fixed interest charges. Here's how to calculate the interest coverage ratio given the provided information:
Net Profit after Taxes: Rs. 1,00,000
Fixed Interest Charges: Rs. 20,000
Income Tax Rate: 60% (0.60)
Step 1: Calculate the earnings before taxes:
Earnings before Taxes = Net Profit after Taxes / (1 - Income Tax Rate)
Earnings before Taxes = Rs. 1,00,000 / (1 - 0.60) = Rs. 1,00,000 / 0.40 = Rs. 2,50,000
Step 2: Calculate the EBIT:
EBT + fixed interest charge = 2,50,000 +20,000 = 2,70,000
Step 3: Calculate the interest coverage ratio:
Interest Coverage Ratio = EBIT / Fixed Interest Charges
Interest Coverage Ratio = Rs. 2,70,000 / Rs. 20,000 = 13.5
Therefore, the interest coverage ratio for the firm is 13.5. This indicates that the firm's earnings before taxes are 13.5 times the fixed interest charges, suggesting a strong ability to cover its interest obligations.
Last updated on Jun 12, 2025
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