Question

From the following details, calculate interest coverage ratio: Net Profit after tax Rs. 1,20,000; 15% Long-term debt 20,00,000; and Tax rate 40%.

• A. 1.67 times
• B. 1.75 times
• C. 1.89 times
• D. 1.95 times

Hint:

Interest coverage = (Profit before tax + Interest) / Interest. First find profit before tax from profit after tax and the 40% tax rate.

Answer 1

The Correct Option is A

Step 1: Build the profit statement backwards.
Let the profit before tax be $x$. Tax at 40% takes $0.4x$, leaving $0.6x$ as profit after tax. We know this equals Rs 1,20,000.

Step 2: Solve for x.
\[ 0.6x = 1{,}20{,}000 \]
\[ x = 2{,}00{,}000 \]
So the profit before tax is Rs 2,00,000.

Step 3: Compute the interest charge.
Interest = 15% of Rs 20,00,000 = Rs 3,00,000. This was already deducted before reaching the profit before tax of Rs 2,00,000.

Step 4: Rebuild the earnings available to pay interest.
Earnings before interest and tax = Rs 2,00,000 + Rs 3,00,000 = Rs 5,00,000.

Step 5: Divide.
Coverage = earnings available divided by interest = $5{,}00{,}000 / 3{,}00{,}000 = 1.666...$, which rounds to 1.67.
The values 1.75, 1.89 and 1.95 cannot be reached from these figures.

Step 6: Conclude.
The firm covers its interest 1.67 times.
\[ \boxed{1.67 \text{ times}} \]

Final Answer:
Interest coverage ratio = 1.67 times (option 1).