The correct answer is option 4- A-II, B-III, C-IV, D-I.
List I
(Concept) |
List II
(Equation) |
| A. Financial leverage |
II. Debt/Equity |
| B. Net Working capital |
III. Current Assets - Current Liabilities |
| C. Interest Coverage Ratio |
IV. EBIT/Interest |
| D. Debt service coverage ratio |
I. (Profit after tax + depreciation + interest + non cash expenses)/
(pref dividend + interest + repayment obligation) |
(A) Financial Leverage- (II) Debt/Equity.
Financial leverage- The proportion of debt in the overall capital is also called financial leverage. Financial leverage is computed as D/E or D/D + E when D is the Debt and E is the Equity. As the financial leverage increases, the cost of funds declines because of increased use of cheaper debt but the financial risk increases. The impact of financial leverage on the profitability of a business can be seen through EBIT-EPS
(B) Net Working Capital- (III) Current Assets - Current Liabilities.
Some part of current assets is usually financed through short-term sources, i.e., current liabilities. The rest is financed through long-term sources and is called net working capital. Thus, NWC = CA – CL (i.e. Current Assets - Current Liabilities.) Thus, net working capital may be defined as the excess of current assets over current liabilities.
(C) Interest Coverage Ratio- (IV) EBIT/Interest.
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.
(D) Debt service coverage ratio- I. (Profit after tax + depreciation + interest + non cash expenses)/(pref dividend + interest + repayment obligation).
Debt Service Coverage Ratio takes care of the deficiencies of 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. | 
