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12.Assume you are a banker who has loaned money to a firm, but that firm is...

12.Assume you are a banker who has loaned money to a firm, but that firm is now facing increased competition and reduced cash flows. Which one of the following ratios would you most closely monitor to evaluate the firm’s ability to repay its loan?

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Answer #1

Answer: times burden covered ratio

This is the ratio of [EBIT / (Interest expense + after-tax Principal payment)]. If the EBIT is high, the ratio would be high and there would be no concern about repayments. This is the best ratio of judging the present scenario, because all the figures in the ratio come from the current income statement. Since the firm faces huge competition and low cash flows, evaluating only on current ratio can’t serve the purpose. Current ratio indicates liquidity position; the firm may have good liquidity but may not have adequate EBIT because of increased competition.

Therefore, times burden covered ratio should be monitored must.

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