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A company has EBIT of Rs. 15 crores with the following borrowings for the current year:

15% Term Loan50
Working Capital:
20% Bank Loan33
Public Deposit @ 14%

The sales of the company are growing and to support this, the company proposes to obtain additional borrowing of Rs. 25 crores. The increase in EBIT is expected to be 20%. Compute the change in interest coverage ratio after the additional borrowing.

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(i) Computation of present Interest Coverage Ratio

Present EBIT = Rs. 15 crores

Term Loan @ 15%7.50
Bank loan @ 20%6.60
Public deposit @ 14%2.10
Present interest charges16.20

Present Interest Coverage Ratio = EBIT / Interest Charges 

= 15 / 16.20 

= 0.93

(ii) Computation of Revised Interest Coverage Ratio

Revised EBIT (120% of Rs. 15 crores) = Rs. 18 crores

Existing charges16.20
Add: Additional Charges (20% of additional borrowings)5.00
Proposed interest charges21.20

Revised Interest Coverage Ratio = Revised EBIT / Proposed Interest Charges 

= 18 / 21.20

= 0.85

The interest coverage ratio is adversely affected as can be seen in the decrease of 8% due to increase in sales. 

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