UPSC Prelims 2020 - Question 62

Here is Question No. 62 a part of our series on UPSC Prelims 2020.

Table of Contents

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.