The correct answer is option 4- A-II, B-IV, C-I, D-III.
| LIST I |
LIST II |
| A) Fixed operating cost |
II) Building rent, insurance premium, salaries etc |
| B) Interest coverage ratio |
IV) Number of times earnings before interest and taxes
of a company covers the interest obligation |
| C) Debt service coverage ratio |
I) The deficiency referred to in the interest coverage ratio |
| D) Capital budgeting decision |
III) Long-term investment decision |
- Fixed operating cost: Operating cost is the cost incurred for the normal day to day running of business. Following are the examples of fixed operating costs(e.g., building rent, Insurance premium, Salaries, etc.) If a business has high fixed operating costs, It must reduce fixed financing costs. Hence, lower debt financing is better. Similarly, if fixed operating cost is less, more of debt financing may be preferred.
- Interest coverage ratio: 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: ICR = 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.
- Debt service coverage ratio: Debt Service Coverage Ratio takes care of the deficiencies referred to in the Interest Coverage Ratio (ICR). The cash profits generated by the operations are compared with the total cash required for the service of the debt and the preference share capital. It is calculated as follows: (Profit after tax + Depreciation + Interest + Non Cash exp.) / (Pref. Div + Interest + Repayment obligation). A higher DSCR indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure.
- Capital budgeting decision: A long-term investment decision is also called a Capital Budgeting decision. It involves committing the finance on a long term basis. For example, making investment in a new machine to replace an existing one or acquiring a new fixed asset or opening a new branch, etc. These decisions are very crucial for any business since they affect its earning capacity in the long run. The size of assets, profitability and competitiveness are all affected by capital budgeting decisions. Moreover, these decisions normally involve huge amounts of investment and are irreversible except at a huge cost. Therefore, once made, it is often almost impossible for a business to wriggle out of such decisions. Therefore, they need to be taken with utmost care
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