Question

From the following information calculate interest coverage ratio :
Net profit after intrest and tax 1,20,000
Rate of tax 40 %
15% debentures 1,00,000
12% mortgage loan 1,00,000

Answer 1

Dear student,

Interest coverage ratio= Net profit before interest and tax
Interest on long term funds

Here, Profit after tax=1,20,000
Tax=40%
Profit before tax=1,20,000*100/60=2,00,000

Here tax is 40% therefore balance profit is only 60% of original profit (profit made before tax calculation)
So to find out total profit made it is enough to multiply profit before tax with reciprocal of percentage of original profit after deducting tax (100-40=60)

Profit before tax= 2,00,000
Add Interest on debentures=1,00,000*15%=15000
Add Interest on mortgage loan=1,00,000*12%=12000
Profit before interest and tax= 2,27,000

Total interest on long term debt=15000+12000=27000
Interest coverage ratio= 2,27,000 = 8.4 times
27,000

Interpretation- Standard ratio on interest coverage is 6 to 7 times.Here the ratio is above ideal ratio indicating that interest charges of the company can be covered even if profit before interest and tax of the company falls to one eighth of the present level.

Regards