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For the year ended March 31, 2017, Net Profit after tax of K X Limited was Rs. 6,00,000. The company has Rs. 40,00,000 12% Debentures of Rs. 100 each. Calculate Interest Coverage Ratio assuming 40% tax rate. State its significance also. Will the Interest Coverage Ratio change if during the year 2017-18, the company decides to redeem debentures of Rs. 5,00,000 and expects to maintain the same rate of Net Profit and assume that the Tax rate will not change. |
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Answer» Interest Coverage Ratio= Net Profit before Interest and Tax/ Interest on Long Term Debts Net Profit after Tax = Rs. 6,00,000 Tax 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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