Question
UPSC Prelims 2020 Question:
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 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.
Answer (Detailed Solution Below)
Option 1: 1 and 2 only
Detailed Solution
Explanation:
- The Interest Coverage Ratio measures a company’s ability to meet required interest expense payments related to its outstanding debt obligations on time. It helps in measuring the present and future risk involved in granting a loan by a bank to a firm. So, statements 1 and 2 are correct.
- The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense during a given period. The higher the Interest Coverage Ratio, the better will be the company’s ability to repay the borrowed funds and interest payments. So, statement 3 is not correct.
Therefore, option (1) is the correct answer.
Subject: Economics | Financial Sectors and Capital Market
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