By NEAS - 7/8/2024 3:08:52 PM
FA Module 7 Interest coverage ratio practice exam questions
covering effective tax rate, net income, pre-tax income, interest expense, fixed charges, other fixed charges, interest coverage ratio, fixed charge coverage ratio
A firm has
● an effective tax rate of 10%
● an interest coverage ratio of 5.5
● a fixed charge coverage ratio of 4.7
● net income of 229
Question 7.1: Pre-tax income
What is the firm’s pre-tax income?
Answer 7.1: net income = pre-tax income × (1 – tax rate)
➾ pre-tax income = net income / (1 – tax rate) = 229 / (1 – 10%) = 254.44
Question 7.2: Tax expense
What is the firm’s tax expense?
Answer 7.2: 254.44 – 229 = 25.44
Tax expense = (net income – pre-tax income)
Question 7.3: Interest expense
What is the firm’s interest expense?
Answer 7.3: (229 + 25.44) / (5.5 – 1) = 56.54
interest coverage ratio = (net income + tax expense + interest expense) / interest expense
➾ interest coverage ratio = (net income + tax expense) / interest expense + 1
➾ interest expense = (net income + tax expense) / (interest coverage ratio – 1)
Question 7.4: Other fixed charges
What are the firm’s other fixed charges (besides interest expense)?
Answer 7.4: (229 + 25.44 – 56.54 × (4.7 – 1) ) / (4.7 – 1) = 12.23
other fixed charges = fixed charges – interest expense
fixed charge coverage ratio = (net income + tax expense + fixed charges) / fixed charges
➾ fixed charge coverage ratio = (net income + tax expense) / fixed charges) + 1
➾ fixed charges = (net income + tax expense) / (fixed charge coverage ratio – 1)
➾ other fixed charges = (net income + tax expense) / (fixed charge coverage ratio – 1) – interest expense
➾ other fixed charges = (net income + tax expense – interest expense × (fixed charge coverage ratio – 1)) / (fixed charge coverage ratio – 1) )
(Other fixed charges = (net income + tax expense – interest expense × (fixed charge coverage ratio – 1) ) / (fixed charge coverage ratio – 1) )
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