8.Solvency Ratios: Proprietary Ratio, Total Assets to Debt Ratio, Interest Coverage Ratio, Assignment# 6

Hello Boys!!

Recapitulation of the last class:

There are 4 Solvency Ratios to be done,out of which we have covered Debt Equity Ratio at length.
Now , You were given formulas and meaning of the other Solvency Ratios in the last class:
Proprietary Ratio
Total Assets to Debt Ratio
Interest Coverage Ratio


Task 

A short Assignment # 6 is made for you All to be attempted in class.
                   

 Assignment# 6

Ques 1    

The proprietary ratio of M Ltd. is 0.80 :1. State with reasons whether the following transactions will increase ,decrease or not change the proprietary ratio..
1. Obtained a loan from Bank 200000 payable after 5 years.
2. purchase machinery for cash 75000 .
3. redeemed 5% redeemable preference shares Rs.100000.
4. issued equity shares to the vendors of machinery purchased for 400000.

(Example)

Proprietary ratio = shareholders funds / total assets = 0.80 :1

1. Obtained a loan from Bank rupees 200000 payable after 5 years. 

Effect: decrease in the ratio. 

Reasons: no change in shareholders funds but total assets will increase by rupees 200000.

2. Purchased machinery for cash rupees 75000. 

Effect: Not change the ratio. 

Reasons: no change in total Assets and shareholders funds. Machinery increases but cash decreases, so total assets remain the same. 

Ques 2    

From the following information, Calculate interest coverage ratio..
net profit after interest and tax           120000
rate of income tax                                     40%
15% debentures                                   100000                     
12% mortgage loan                              100000

Ans. 8.41 times

Answers to Assignment # 6

Ques. 1

3. Redeemed 5% redeemable preference shares rupees 100000. 
Effect : decrease in the ratio. 
Reasons: both shareholders funds and total assets decrease by the same amount. since original proprietary ratio is 0.08:1, that is less than 1, therefore the revised ratio will decrease. 

4. Issued equity shares to the vendors of machinery purchased for rupees 400000. 
Effect: increase in the ratio. 
Reasons: both shareholders funds and total assets increased by the same amount. Since original proprietary ratio is 0.08:1 that is less than 1, therefore, the revised ratio will increase.

Ques. 2
Interest coverage ratio = net profit before interest and tax/ interest on long term debt
net profit before tax = net profit after tax / 100 - tax rate  x 100 
= 120000/60 * 100 = 2 lakh 

interest on long term debts = 15% of 100000 + 12% of 1 lakh 
= 15000 + 12000 = 27000
therefore, net profit before interest and tax = net profit before tax + interest on long term debts
= 2 lakh + 27000 = 227000
Thus, interest coverage ratio = 227000/ 27000 = 8.41 times