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For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ?
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Interest Coverage Ratio
The interest coverage ratio is a financial ratio that measures a company's ability to pay its interest expenses on its outstanding debt. It is calculated by dividing the company's earnings before interest and taxes (EBIT) by its interest expenses.
The formula for interest coverage ratio is as follows:
Interest Coverage Ratio = EBIT / Interest Expenses
Calculation of Interest Coverage Ratio
Given that the net profit after tax of K X Limited for the year ended 31st March 2017 is Rs. 6,00,000 and the company has Rs. 40,00,000, 12% debentures of Rs. 100 each, we can calculate the interest coverage ratio as follows:
1. Calculate the interest expenses:
Interest Expenses = Debentures * Interest Rate
= Rs. 40,00,000 * 12% = Rs. 4,80,000
2. Calculate the EBIT:
EBIT = Net Profit After Tax + Interest Expenses * (1 - Tax Rate)
= Rs. 6,00,000 + Rs. 4,80,000 * (1 - 0.40) = Rs. 6,00,000 + Rs. 2,88,000 = Rs. 8,88,000
3. Calculate the interest coverage ratio:
Interest Coverage Ratio = EBIT / Interest Expenses
= Rs. 8,88,000 / Rs. 4,80,000 ≈ 1.85
Significance of Interest Coverage Ratio
The interest coverage ratio is an important measure of a company's financial health and stability. It indicates the company's ability to generate enough earnings to cover its interest expenses. A higher interest coverage ratio is generally considered favorable as it means the company has more income available to pay its interest obligations.
A ratio of 1 or lower indicates that the company's earnings are just enough to cover its interest expenses, and any decrease in earnings could lead to difficulties in meeting interest payments. A ratio below 1 implies that the company is not generating sufficient income to cover its interest expenses, which can signify financial distress and potential default on debt.
Effect of Debenture Redemption on Interest Coverage Ratio
If during the year 2017-18, K X Limited decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and tax rate, the interest coverage ratio will change.
1. Calculate the new interest expenses:
New Interest Expenses = (Debentures - Debenture Redemption) * Interest Rate
= (Rs. 40,00,000 - Rs. 5,00,000) * 12% = Rs. 4,20,000
2. Calculate the new EBIT:
New EBIT = Net Profit After Tax + New Interest Expenses * (1 - Tax Rate)
= Rs. 6,00,000 + Rs. 4,20,000 * (1 - 0.40) = Rs. 6,00,000 + Rs. 2,52,000 = Rs. 8,52,000
3. Calculate the new interest coverage ratio:
New Interest Coverage Ratio = New EBIT / New Interest Expenses
= Rs. 8,52,000 / Rs. 4,20,000 ≈ 2
The interest coverage ratio is a financial ratio that measures a company's ability to pay its interest expenses on its outstanding debt. It is calculated by dividing the company's earnings before interest and taxes (EBIT) by its interest expenses.
The formula for interest coverage ratio is as follows:
Interest Coverage Ratio = EBIT / Interest Expenses
Calculation of Interest Coverage Ratio
Given that the net profit after tax of K X Limited for the year ended 31st March 2017 is Rs. 6,00,000 and the company has Rs. 40,00,000, 12% debentures of Rs. 100 each, we can calculate the interest coverage ratio as follows:
1. Calculate the interest expenses:
Interest Expenses = Debentures * Interest Rate
= Rs. 40,00,000 * 12% = Rs. 4,80,000
2. Calculate the EBIT:
EBIT = Net Profit After Tax + Interest Expenses * (1 - Tax Rate)
= Rs. 6,00,000 + Rs. 4,80,000 * (1 - 0.40) = Rs. 6,00,000 + Rs. 2,88,000 = Rs. 8,88,000
3. Calculate the interest coverage ratio:
Interest Coverage Ratio = EBIT / Interest Expenses
= Rs. 8,88,000 / Rs. 4,80,000 ≈ 1.85
Significance of Interest Coverage Ratio
The interest coverage ratio is an important measure of a company's financial health and stability. It indicates the company's ability to generate enough earnings to cover its interest expenses. A higher interest coverage ratio is generally considered favorable as it means the company has more income available to pay its interest obligations.
A ratio of 1 or lower indicates that the company's earnings are just enough to cover its interest expenses, and any decrease in earnings could lead to difficulties in meeting interest payments. A ratio below 1 implies that the company is not generating sufficient income to cover its interest expenses, which can signify financial distress and potential default on debt.
Effect of Debenture Redemption on Interest Coverage Ratio
If during the year 2017-18, K X Limited decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and tax rate, the interest coverage ratio will change.
1. Calculate the new interest expenses:
New Interest Expenses = (Debentures - Debenture Redemption) * Interest Rate
= (Rs. 40,00,000 - Rs. 5,00,000) * 12% = Rs. 4,20,000
2. Calculate the new EBIT:
New EBIT = Net Profit After Tax + New Interest Expenses * (1 - Tax Rate)
= Rs. 6,00,000 + Rs. 4,20,000 * (1 - 0.40) = Rs. 6,00,000 + Rs. 2,52,000 = Rs. 8,52,000
3. Calculate the new interest coverage ratio:
New Interest Coverage Ratio = New EBIT / New Interest Expenses
= Rs. 8,52,000 / Rs. 4,20,000 ≈ 2
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For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ?
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For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ? for Commerce 2024 is part of Commerce preparation. The Question and answers have been prepared according to the Commerce exam syllabus. Information about For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ? covers all topics & solutions for Commerce 2024 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ?.
For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ? for Commerce 2024 is part of Commerce preparation. The Question and answers have been prepared according to the Commerce exam syllabus. Information about For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ? covers all topics & solutions for Commerce 2024 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ?.
Solutions for For the year ended 31st March 2017, net profit after tax of K X limited was Rs. 6,00,000. The company has Rs. 40,00,000, 12% debentures of Rs. 100 each. Calculate interest coverage ratio assuming 40% tax rate. State its significance also. Will the interest coverage ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of net profit and assume that the tax rate will not change. ? in English & in Hindi are available as part of our courses for Commerce.
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