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Target Exam

CUET

Subject

Business Studies

Chapter

Financial Management

Question:

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.

Options:

$ICR=\frac{Debt}{Debt+Equity}$

$ICR=\frac{\text{Profit after tax}}{\text{Preference Dividend}}$

$ICR=\frac{EBIT}{Interest}$

$ICR=\frac{EBIT}{\text{Non cash expenses}}$

Correct Answer:

$ICR=\frac{EBIT}{Interest}$

Explanation:

The correct answer is option (3) : $ICR=\frac{EBIT}{Interest}$.

Interest Coverage Ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation.
This may be calculated as follows:EBIT/ Interest.
The higher the ratio, lower shall be the risk of company failing to meet its interest payment obligations. However, this ratio is not an adequate measure. A firm may have a high EBIT but low cash balance. Apart from interest, repayment obligations are also relevant.

 

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