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Question
The following particulars are given to you:
| ₹ | |
| Share Capital | 1,00,000 |
| Reserve and Surplus | 1,50,000 |
| Current Liabilities | 4,00,000 |
| Current Assets | 5,50,000 |
| Tangible Fixed Assets | 7,00,000 |
| Loans @10% | 4,00,000 |
| 12% Debentures | 2,00,000 |
Net Profit for the year after interest and tax was ₹ 96,000. Rate of lncome Tax was 50%.
Calculate:
- Debt-Equity Ratio
- Proprietary Ratio
- Interest Coverage Ratio
Also give your comments.
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Solution
(i) Debt-Equity Ratio = `("Long-term Debts")/("Shareholder’s Funds")`
Long-term Debts = Loans + 12% Debentures
= ₹ 4,00,000 + ₹ 2,00,000
= ₹ 6,00,000
Shareholder’s Funds = Share Capital + Reserve and Surplus
= ₹ 1,00,000 + ₹ 1,50,000
= ₹ 2,50,000
Debt-Equity Ratio = `(₹ 6,00,000)/(₹ 2,50,000)`
= 2.4 : 1
(ii) Proprietary Ratio = `"Shareholder’s Funds"/"Total Assets" xx 100`
Total Assets = Current Assets + Property, Plant & Equipment
= ₹ 5,50,000 + ₹ 7,00,000
= ₹ 12,50,000
Proprietary Ratio = `(₹ 2,50,000)/(₹ 12,50,000) xx 100`
= 20%
(iii) Interest Coverage Ratio = `"Net Profit before Interest & Tax"/"Fixed Interest Charges"`
= Fixed Interest Charges = 12% Interest on Debentures of ₹ 2,00,000 + 10% Interest on Loan of ₹ 4,00,000
= ₹ 24,000 + ₹ 40,000
= ₹ 64,000
Net Profit before Interest and Tax is Calculated as follows:
Net Profit after Interest and Tax = ₹ 96,000
Net Profit before Tax = `96,000 xx 100/50`
= ₹ 1,92,000
Net Profit before Interest and Tax = Net Profit before Tax + Fixed Interest Charges
= ₹ 1,92,000 + ₹ 64,000
= ₹ 2,56,000
Interest Coverage Ratio = `(₹ 2,56,000)/(₹ 64,000)`
= 4 times
Comments:
(i) The company’s debt-equity ratio exceeds the permissible norm of 2 : 1, making it unsatisfactory. It indicates a risky financial situation over time.
(ii) The Company’s Proprietary Ratio of only 20% indicates a weak long-term financial condition, as equity funds only 20% of total assets.
(iii) This company’s interest-coverage ratio is 4 times, which is lower than the normal range of 6 or 7. If a company’s profits decline, it may find it difficult to pay the interest on long-term loans on time.
