AuthorTopic: Ratio clarification
@2012-04-11 11:29:25
I got confused by the apparent use of interest coverage and long-term debt-to-equity definitions.

In the AN notes example the interest coverage ratio appears to be calculated using (net income + taxes + interest expense)/interest expense. This is consistent with what I learned at school. However, in the CFAI books interest coverage seems to be defined as (CFO + taxes + interest expense)/interest expense. To add more confusion, in SS10 there is an other definition of interest coverage using the EBIT/interest expense variant.

Which one to use when? Probably better to remember the formula as "interest coverage by CFO" and "interest coverage by EBIT"?

With regard to long-term debt to equity, it seems, that sometimes deferred tax liabilities are added and some times they are not. I.e. taxes are never mentioned in the formulas, but in the textbook example they are added.

Again, which way to compute the ratio under what circumstances? I personally would always include deferred taxes, since these taxes will have to be paid at some point in time. Is this a recommended practice?

CFA Discussion Topic: Ratio clarification

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I was very pleased with your notes and question bank. I especially like the mock exams because it helped to pull everything together.
Martin Rockenfeldt

Martin Rockenfeldt