- CFA Exams
- CFA Level I Exam
- Study Session 7. Financial Reporting and Analysis (2)
- Reading 22. Understanding Balance Sheets
- Subject 5. Uses and Analysis of the Balance Sheet

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**CFA Practice Question**

Which of the following statement(s) is (are) true?

II. The interest coverage ratio is computed by dividing the annual operating income by the annual interest expense.

III. The current ratio is equal to current assets divided by current liabilities.

IV. The debt ratio shows how many times the company earns its annual interest obligations.

I. A high debt ratio indicates an extensive use of leverage.

II. The interest coverage ratio is computed by dividing the annual operating income by the annual interest expense.

III. The current ratio is equal to current assets divided by current liabilities.

IV. The debt ratio shows how many times the company earns its annual interest obligations.

A. I, II and III

B. I, II, III and IV

C. I, III and IV

**Explanation:**II. The interest coverage ratio expresses the ability of the business to pay the interest on debt from current income. If operating income totals $50,000 and interest costs total $10,000 the interest coverage ratio would be 5:1.

III. The current ratio is the most common measure of solvency.

IV. The interest coverage ratio shows how many times the company earns its annual interest obligations. The debt ratio (total liabilities/total assets) measures the percentage of capital structure financed by creditors.

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**User Contributed Comments**
2

User |
Comment |
---|---|

EmmaBeale |
GAAHHHH - I thought Int coverage was EBIT / Int - not Net income! |

mjhuff |
It is. EBIT = Operating income (at least for the purpose of this exam). Net income reduces EBIT/OI by interest & taxes and is not a component of the interest coverage ratio. |