1. It helps in understanding the present risk of a firm to that a bank is going to give a loan to. 

2. It helps in evaluating the emerging risk of a firm to 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. 

(a) 1 and 2 only

 (b) 2 only 

(c) 1 and 3 only 

(d) 1, 2 and 3 

Answer: a

Explanation:

Interest Coverage Ratio 

It is a ratio which deals with the servicing of interest on loan. It is a measure of security of interest payable on long-term debts. It expresses the relationship between profits available for payment of interest and the amount of interest payable. 

The interest coverage ratio measures how well a firm can pay the interest due on outstanding debt.

The interest coverage ratio helps lenders, investors, and creditors determine a company’s riskiness for future borrowing.

Hence, statements 1 and 2 are correct.

It is calculated as follows: 

Interest Coverage Ratio = Net Profit before Interest and Tax / Interest on long-term debts 

Significance: It reveals the number of times interest on long-term debts is covered by the profits available for interest. A higher ratio ensures safety of interest on debts.

Hence, statement 3 is incorrect.

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