Easy

Aval Ltd. is engaged in the business of the export of canvas goods and bags. In the past, the performance of the company was above expectations. In line with the latest demand in the market, the company decided to venture into leather goods for which it required specialized machinery. For this, the Finance Manager Prabhu prepared a financial blueprint for the organization's future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at the right time. He also collected the relevant data about the profit estimates for the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds, he is trying to find alternative sources from outside. The company is willing to go for a public issue of shares and debentures to be made under SEBI guidelines. Public issue of shares and debentures requires considerable outlay of funds too. Due to extensive operations, the manager is of the viewpoint that a company may have to ensure that earnings before interest and taxes of a company should cover the interest obligation. The manager also felt that the cash profits generated by the operations need to be compared with the total cash required for the service of the debentures and the preference share capital.

"Due to extensive operations, the manager is of the viewpoint that a company may have to ensure that earnings before interest and taxes of a company should cover the interest obligation". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Cash Flow Position

Interest Coverage Ratio

Debt Service Coverage Ratio

Tax rate

✅ Correct Option: 2

Option 1 -> Cash Flow Position refers to the actual cash available to meet various obligations, not specifically the relationship between EBIT and interest expenses. Option 2 -> Interest Coverage Ratio measures how many times EBIT can cover interest obligations (EBIT/Interest Expense), which directly matches the manager's concern about EBIT covering interest. Option 3 -> Debt Service Coverage Ratio considers both principal and interest payments in relation to operating income or cash flow, which is broader than just interest coverage. Option 4 -> Tax rate relates to tax burden on profits and doesn't directly address the relationship between EBIT and interest obligations. Hence, Option 2: Interest Coverage Ratio -> The manager's statement that "earnings before interest and taxes should cover the interest obligation" is the exact definition of Interest Coverage Ratio (ICR = EBIT/Interest Expense). This ratio is a critical factor in capital structure decisions as it indicates the company's ability to meet interest payments from operating profits, helping determine the optimal debt level the company can sustain -> correct

Question 46

"The company is willing to go for a public issue of shares and debentures to be made under SEBI guidelines". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Question 47

"Finance Manager Prabhu prepared a financial blueprint for the organization's future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at the right time". Identify the concept of financial management highlighted in the aforesaid statement.

Question 48

"Public issue of shares and debentures requires considerable outlay of funds at the time of issue too". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Question 50

Which financial ratio will establish the relation between the cash profits generated by the operations and the total cash required for the service of the debentures and the preference share capital?

"Due to extensive operations, the manager is of the viewpoint that a company may have to ensure that earnings before interest and taxes of a company should cover the interest obligation". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Solution

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