Interest Coverage Ratio (ICR) Calculation Quiz
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Questions and Answers

What is the meaning of 'capital gearing' or 'financial leverage'?

  • The ratio between equity and interest payments
  • The ratio between debt and assets
  • The ratio between equity and assets
  • The ratio between equity and debt (correct)
  • What is the main objective of optimizing the capital structure of a business?

  • Minimizing the value of the equity share
  • Maximizing the firm's financial risk
  • Reducing the proportion of debt in the overall capital
  • Emphasizing increasing the shareholders' wealth (correct)
  • What does 'high gearing' or 'working on thin equity' refer to in the context of capital structure?

  • When the proportion of debt is low
  • When there is no debt in the capital structure
  • When equity dominates the capital structure
  • When the proportion of debt is high (correct)
  • How does the cash flow position impact the choice of capital structure?

    <p>It affects the size of projected cash flows before issuing debt</p> Signup and view all the answers

    What does business finance involve?

    <p>Estimation of funds required, sources of funds, and investment of finance</p> Signup and view all the answers

    Why is the availability of sufficient finance essential for carrying out business operations?

    <p>To maintain the flow of production</p> Signup and view all the answers

    What does the term 'capital' refer to in the context of business finance?

    <p>The investment made in an enterprise for the purpose of earning profits</p> Signup and view all the answers

    How does business finance help firms to face challenges such as recession and trade cycle?

    <p>By enabling the firm to avail various business opportunities</p> Signup and view all the answers

    What affects the requirement for working capital during a period of depression?

    <p>Low sales and production</p> Signup and view all the answers

    In which season would a business require higher working capital according to the text?

    <p>Peak season</p> Signup and view all the answers

    What factor affects the amount of funds required for raw materials and expenses in a business?

    <p>Duration and length of production cycle</p> Signup and view all the answers

    What results in a higher requirement of working capital for a firm?

    <p>Liberal credit policy resulting in higher amount of debtors</p> Signup and view all the answers

    What does the Debt Service Coverage Ratio (DSCR) indicate?

    <p>The ability to meet cash commitments and increase debt in the capital structure</p> Signup and view all the answers

    How does a higher Return on Investment (RoI) affect a company's ability to use debt?

    <p>It allows the company to use trading on equity to increase its EPS</p> Signup and view all the answers

    How does a lower cost of debt impact a firm's capacity to employ debt?

    <p>It increases the firm's capacity to employ higher debt</p> Signup and view all the answers

    How does the tax rate affect the cost of debt?

    <p>It makes debt relatively cheaper and increases its attraction vis-à-vis equity</p> Signup and view all the answers

    Study Notes

    Capital Structure and Business Finance

    • Capital gearing or financial leverage refers to the proportion of debt and equity in a company's capital structure.

    Objectives of Capital Structure

    • The main objective of optimizing the capital structure of a business is to maximize shareholders' wealth.

    High Gearing

    • High gearing or working on thin equity refers to a situation where a company has a high proportion of debt in its capital structure.

    Cash Flow and Capital Structure

    • The cash flow position of a company impacts the choice of capital structure, as a company with a strong cash flow position can take on more debt.

    Business Finance

    • Business finance involves the management of a company's funds, including sourcing, allocation, and utilization of funds to achieve business objectives.

    Importance of Finance

    • The availability of sufficient finance is essential for carrying out business operations, as it enables companies to invest in assets, pay expenses, and meet financial obligations.

    Capital in Business Finance

    • In the context of business finance, 'capital' refers to the funds invested in a business, including debt and equity.

    Managing Challenges

    • Business finance helps firms to face challenges such as recession and trade cycle by providing them with the necessary funds to invest in new opportunities and manage risks.

    Working Capital Requirements

    • During a period of depression, the requirement for working capital is affected by the need to maintain a higher level of inventory and provide more credit to customers.

    Seasonal Working Capital Requirements

    • A business may require higher working capital during peak seasons, such as summer or festive seasons, when demand is higher.

    Factors Affecting Working Capital

    • The amount of funds required for raw materials and expenses in a business is affected by the level of production, seasonal fluctuations, and inflation.

    Higher Working Capital Requirements

    • A higher requirement of working capital for a firm results from an increase in production, expansion of business, or a delay in receiving payments from customers.

    Debt Service Coverage Ratio (DSCR)

    • The DSCR indicates a company's ability to pay its debt obligations, including interest and principal, from its earnings.

    Return on Investment (RoI) and Debt

    • A higher RoI affects a company's ability to use debt, as it increases the company's capacity to service debt.

    Cost of Debt

    • A lower cost of debt impacts a firm's capacity to employ debt, making it a more attractive option for financing.

    Tax Rate and Cost of Debt

    • The tax rate affects the cost of debt, as interest payments on debt are tax-deductible, reducing the effective cost of debt.

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    Description

    Test your knowledge of interest coverage ratio with this quiz. Learn to calculate the interest coverage ratio using the formula and understand its implications on a company's financial health.

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