A high Debt Service Coverage Ratio indicates:

Answer & explanation

Correct answer: option 2

The correct answer is Option (2) → A company's potential to increase debt component

Option (1) A company's potential to decrease equity component — Incorrect. DSCR measures whether cash profits can cover the payments due on debt. It says nothing about reducing equity. A high DSCR allows a company to take on more debt, and it can do so without cutting its equity.
Option (2) A company's potential to increase debt component — Correct. The Debt Service Coverage Ratio compares the cash profits from operations with the total cash needed to service debt and preference share capital: interest, repayment and preference dividend. A high ratio means cash profits cover these payments comfortably. Such a company can safely borrow more, so it has the potential to increase the debt component of its capital structure. This is why DSCR is one of the factors affecting the choice of capital structure.
Option (3) Reduced ability to meet cash commitments — Incorrect. The feature is reversed. A high DSCR shows a better ability to meet cash commitments. It is a low DSCR that shows a reduced ability.
Option (4) A company's potential to decrease debt component — Incorrect. The feature is reversed here too. A company with a high DSCR can afford more debt, not less. A low DSCR is what forces a company to keep its debt low.

Note: In the original question, both Option (2) and Option (3) were correct as per the NTA Answer Key. The paper printed Option (2) as A company’s potential to increase debt component and Option (3) as Enhanced credit-meeting capacity. For the benefit of students and to ensure a single answer, Option (3) has been changed to Reduced ability to meet cash commitments.

NCERT (2026-27 Edition): “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.”

A high Debt Service Coverage Ratio indicates:

Answer & explanation

Correct answer: option 2

The correct answer is Option (2) → A company's potential to increase debt component

Option (1) A company's potential to decrease equity component — Incorrect. DSCR measures whether cash profits can cover the payments due on debt. It says nothing about reducing equity. A high DSCR allows a company to take on more debt, and it can do so without cutting its equity.
Option (2) A company's potential to increase debt component — Correct. The Debt Service Coverage Ratio compares the cash profits from operations with the total cash needed to service debt and preference share capital: interest, repayment and preference dividend. A high ratio means cash profits cover these payments comfortably. Such a company can safely borrow more, so it has the potential to increase the debt component of its capital structure. This is why DSCR is one of the factors affecting the choice of capital structure.
Option (3) Reduced ability to meet cash commitments — Incorrect. The feature is reversed. A high DSCR shows a better ability to meet cash commitments. It is a low DSCR that shows a reduced ability.
Option (4) A company's potential to decrease debt component — Incorrect. The feature is reversed here too. A company with a high DSCR can afford more debt, not less. A low DSCR is what forces a company to keep its debt low.

“A higher DSCR indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure.”