A company has an EBIT of Rs. 12 lakh. It already has debentures of Rs. 40 lakh at 10% p.a. It now takes a further loan of Rs. 20 lakh at 10% p.a. Its EBIT stays at Rs. 12 lakh. What will be its interest coverage ratio (ICR) after the new loan?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → 2 times
Given:
EBIT = Rs. 12 lakh
Debentures = Rs. 40 lakh at 10% p.a.
New loan = Rs. 20 lakh at 10% p.a.
Formula: ICR = EBIT / Interest
Interest on debentures = 10% of 40 = Rs. 4 lakh
Interest on new loan = 10% of 20 = Rs. 2 lakh
Total interest = 4 + 2 = Rs. 6 lakh
ICR = 12 / 6 = 2 times
Result: the ICR falls to 2 times, so the cover for interest is now thinner.
Option (1) 2 times — Correct. As worked out above.
Option (2) 3 times — Incorrect. This is 12 / 4, the ICR before the new loan.
Option (3) 6 times — Incorrect. This is 12 / 2, which counts the interest on the new loan alone.
Option (4) 1 time — Incorrect. This is (12 − 6) / 6, which takes the interest off EBIT first. ICR uses EBIT itself.
NCERT (2026-27 Edition): “2. 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. … 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.” |