Question

From the following information, calculate 'debt-service ratio' and write your comment on it. Profit after interest and tax 1,08,000 , rate of income tax 40% , 8% debentures 2,50,000.

Answer 1

Given Profit/Earnings after tax and interest = 108000

8% debentures worth 250000..so interest amount will be 250000@8% = 20000=fixed interest charges

Rate of Income tax =40%

let profit before interest and tax = x

then Profit after interest and tax = 108000

((x-20000)- 40%(x-20000) = 108000
(x-20000)( 1 - 0.4) = 108000
(x-20000) = 108000/0.6
x-20000 =180000
x=180000+20000
x= profit before interest and tax= 200000

We know that Debt service ratio = profit before interest and tax/fixed interest charges

200000/20000 = 10

Debt service provides us an information about the availability of cash flows to meet debt payments..

ideal ratio is 1.33...here in this question its 10..so the performance of the company is Excellent