Rahul is a CFO of Narayan Limited. His company required funds for future expansion. He has both the options of raising funds through Debt or equity. So, he asks his Finance Manager Tarun to calculate ICR of the company in order to choose Debt as the source of finance.
Determine the formula, Tarun is going to use for the Computation.
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → ICR = EBIT ÷ Interest
Option (1) ICR = Debt ÷ (Debt + Equity) — Incorrect. This shows what part of the total funds comes from debt. It does not compare earnings with interest.
Option (2) ICR = Profit after tax ÷ Preference Dividend — Incorrect. This has no interest in it at all. So it cannot tell whether the company can pay its interest.
Option (3) ICR = EBIT ÷ Interest — Correct. The interest coverage ratio shows how many times the earnings before interest and taxes (EBIT) cover the interest payment. A higher ratio means less risk that the company will fail to pay interest. That is why Tarun looks at it before choosing debt.
Option (4) ICR = EBIT ÷ Non cash expenses — Incorrect. Non-cash expenses are not interest. This is not the ICR formula.
NCERT (2026-27 Edition):
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