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Question
From the following information, calculate interest coverage ratio and give your comments also:
| ₹ | |
| Net Profit after Interest and Tax | 1,20,000 |
| Rate of Income Tax | 50% |
| 15% Debentures | 1,00,000 |
| 12% Mortgage Loan | 1,00,000 |
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Solution
Interest Coverage Ratio = `"Net Profit before Interest and Tax"/"Fixed Interest Charges"`
Let the Net Profit before Tax be ₹ x.
Net Profit after Tax = Net Profit before Tax − Tax
₹ 1,20,000 = x − 50% of x
x − `50/100`x = ₹ 1,20,000
`(100x - 50x)/100` = ₹ 1,20,000
`(50x)/100` = ₹ 1,20,000
x (Net Profit before Tax) = `(1,20,000 xx 100)/50`
= ₹ 2,40,000
Fixed Interest Charges = 15% of ₹ 1,00,000 + 12% of ₹ 1,00,000
= ₹ 15,000 + ₹ 12,000
= ₹ 27,000
Net Profit before Interest and Tax = Net Profit before Tax + Fixed Interest Charges
= ₹ 2,40,000 + ₹ 27,000
= ₹ 2,67,000
Interest Coverage Ratio = `(₹ 2,67,000)/(₹ 27,000)`
= 9.89 Times
Comments: An interest coverage ratio of 6 to 7 times is considered appropriate. This company's actual interest coverage ratio is approximately 10 times, indicating that it will be able to pay long-term loan interest on a regular basis.
