Debt Service Coverage Ratio
This ratio is an extension of the above interest coverage ratio. It indicates the ability of the firm to repay the interest and installments on time. This ratio is important from lenders' point of view. The formula is -
The rule - the higher the ratio, the better it is. A high debt service coverage ratio implies better security to the lenders. This ratio is similar to interest coverage ratio used by managers to decide upon the amount of debt obligations to be raised. In fact, both interest coverage ratio and debt service coverage ratio are used in conjunction by managers before they decide upon the quantum of debt to be issued. It indicates that the net profit before interest and taxes is adequate to cover the interest and principal repayment.
Calculate the debt service coverage ratio, if the company earns a profit of Rs.2,00,000 after interest and taxes; and 5% debentures payable in 5 equal installments are Rs.2,00,000. The tax rate is 50%.
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