What is the importance of the term "Interest Coverage Ratio" of a firm in India?It helps in understa

Q: What is UPSC Prelims?

UPSC Prelims is a competitive examination conducted in India. This question is from the 2020 UPSC Prelims Economy paper.

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Question

What is the importance of the term "Interest Coverage Ratio" of a firm in India?It helps 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:

Accepted Answer

Correct Answer: A — 1 and 2 onlyStep-by-step Solution:Interest Coverage Ratio (ICR) = Earnings Before Interest and Taxes (EBIT) / Interest Expense.Statement 1: Correct. A low ICR indicates higher risk of default on interest payments, so banks assess this before lending. ✓Statement 2: Correct. ICR also helps evaluate future or emerging risk (trend analysis over time). ✓Statement 3: Incorrect. A higher ICR means the firm earns more relative to its interest obligations, so it has better debt‑servicing ability, not worse. ✗Why other options are incorrect:Option B (2 only): Misses statement 1.Option C (1 and 3): Statement 3 false.Option D (1,2,3): Statement 3 false.Key Concept: ICR is a solvency ratio. An ICR below 1 indicates the firm does not generate enough operating profit to cover interest. In India, banks often consider ICR

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