The following information is given for two firms (Rs. in lakh):
| Firm X | Firm Y | |
|---|---|---|
| Profit after tax | 5 | 4 |
| Depreciation | 1.5 | 2 |
| Interest | 2 | 3 |
| Other non-cash expenses | 0.5 | 1 |
| Preference dividend | 0.5 | 1 |
| Repayment obligation | 1.5 | 4 |
Which firm is in a better position to meet its cash commitments and to increase the debt component in its capital structure?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Firm X, because its DSCR is 2.25 times against 1.25 times for Firm Y.
Given (Rs. in lakh):
Firm X: Profit after tax 5; Depreciation 1.5; Interest 2; Non-cash expenses 0.5; Preference dividend 0.5; Repayment 1.5
Firm Y: Profit after tax 4; Depreciation 2; Interest 3; Non-cash expenses 1; Preference dividend 1; Repayment 4
Formula: DSCR = (Profit after tax + Depreciation + Interest + Non-cash expenses) / (Preference dividend + Interest + Repayment obligation)
Firm X: cash profits = 5 + 1.5 + 2 + 0.5 = 9
Firm X: debt service = 0.5 + 2 + 1.5 = 4
Firm X: DSCR = 9 / 4 = 2.25 times
Firm Y: cash profits = 4 + 2 + 3 + 1 = 10
Firm Y: debt service = 1 + 3 + 4 = 8
Firm Y: DSCR = 10 / 8 = 1.25 times
Result: Firm X has the higher DSCR (2.25 times).
Option (1) Firm X, because its DSCR is 2.25 times against 1.25 times for Firm Y. — Correct. Firm X has the higher DSCR, so it has more cash profit for each rupee of commitments. A higher DSCR means a better ability to meet cash commitments and to raise more debt.
Option (2) Firm Y, because its cash profits of Rs. 10 lakh are higher than Rs. 9 lakh of Firm X. — Incorrect. Cash profits alone do not show the position. They must be compared with the debt service, and Firm Y's commitments of Rs. 8 lakh are twice those of Firm X.
Option (3) Firm Y, because its DSCR of 1.25 times is lower, which leaves more room for debt. — Incorrect. This turns the ratio round. A lower DSCR means less cash to cover each rupee of commitments, so less room for new debt.
Option (4) Firm X, because its DSCR is 3.6 times against 2.5 times for Firm Y. — Incorrect. These figures leave out the repayment obligation: 9 / 2.5 = 3.6 and 10 / 4 = 2.5.
NCERT (2026-27 Edition): “3. Debt Service Coverage Ratio (DSCR): 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. … A higher DSCR indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure.” |