What is the importance of the term “Interest Coverage Ratio” of a firm in India? 1. It help in understanding the present risk of a firm that a bank is going to give loan to. 2. It helps in evaluating the emerging risk of a firm that a bank is going to give loan to. 3. 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:

QUESTION

Hard

Economy

Prelims 2020

What is the importance of the term “Interest Coverage Ratio” of a firm in India?

It help 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:

Select an option to attempt

Explanation

Statement 1 is correct: The Interest Coverage Ratio (ICR) helps in understanding the present risk of a firm’s ability to pay interest on its debt. A low ICR indicates higher risk, as the firm may not have enough earnings to cover its interest obligations.

Statement 2 is correct: The ICR is also used to assess emerging risks for a firm. A declining ICR over time can signal growing difficulties in servicing debt, which can be important for banks evaluating the risk of granting new loans.

Statement 3 is incorrect: A higher Interest Coverage Ratio actually indicates better ability to service debt, not worse. A high ratio means the firm has a sufficient earnings buffer to cover its interest expenses, which is seen as a positive sign by creditors.

Hence, option A is the correct answer.

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