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Asked by Shabana Last Modified
Answer 
Dr Mukul Singhal
Management Professional
Solution:
Interest Coverage Ratio= Net Profit before Interest and Tax/ Interest on Long Term Debts
Net Profit after Tax = Rs. 6,00,000Tax Rate = 40 %
Net Profit before tax = 100/(100 – Tax) X Net Profit after tax
= 100/ 60 X 6,00,000 = 10,00,000
Net Profit before Interest & Tax = Net Profit before tax + Interest on Long Term Debts
= 10,00,000 + 4,80,000 = 14,80,000
Interest Coverage Ratio= Net Profit before Interest and Tax / Interest on Long Term Debts
= 14,80,000 / 4,80,000 = 3.08 Times
Significance of Interest Coverage Ratio: It reveals the number of times Interest on Long Term Debts is covered by the profits available. A higher ratio ensures safety of interest on Long Term Debts.
The Interest coverage ratio will improve if the company decides to redeem Rs. 5,00,000 debentures assuming that Net Profit after interest and the tax rate will be same.
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