Here is Question No. 62 a part of our series on UPSC Prelims 2020.
Q62. What is the importance of the term “Interest Coverage Ratio” of a firm in India?
- It helps in understanding the present risk of a firm that a bank is going to give
a loan to. - It helps in evaluating the emerging risk of a firm that a bank is going to give
loan to. - The higher a borrowing firm’s level of Interest Coverage Ratio, the worse is
its ability to service its debt.
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer: A
- Interest Coverage Ratio is an indicator of a company’s ability to pay interest out of its current earnings. It is expressed as the
number of times that the interest can be covered from its current earnings. - Statement 1 is correct: It can help in understanding the present risk, as a firm with a low-interest coverage ratio just may
not have enough earnings in order to meet the annual interest obligations. - Statement 2 is correct: ICR is commonly used by lenders, creditors, and investors to determine the company’s riskiness relative to its current debt or for future borrowing.
- Statement 3 is not correct: The higher the interest coverage ratio the better. The lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.
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