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ABC Enterprises posted a profit before interest and tax (PBIT) of Rs.2,00,000 for the financial year. Its shareholders' equity is Rs.2,00,000 and long‑term debt is Rs.1,00,000. Interest expense for the year is Rs.40,000. (a) Calculate the Return on Capital Employed (ROCE). (b) Compute the Interest Coverage Ratio. (c) Comment on the firm’s overall financial performance based on these ratios.

hard 5 marks Class 12 · Accountancy · Accounting Ratios
Answer
ROCE = 66.67%; Interest Coverage Ratio = 5

The correct answer is ROCE = 66.67%; Interest Coverage Ratio = 5 — Hence, ROCE = 66.67% and Interest Coverage Ratio = 5.

Step-by-step solution

  1. Capital Employed = Shareholders' Equity + Long‑term Debt = 2,00,000 + 1,00,000 = 3,00,000.
  2. ROCE formula: ROCE = (PBIT ÷ Capital Employed) × 100.
  3. Substitute values: = (2,00,000 ÷ 3,00,000) × 100 = 0.6667 × 100 = 66.67%.
  4. Interest Coverage Ratio formula: Interest Coverage = PBIT ÷ Interest Expense.
  5. Insert numbers: = 2,00,000 ÷ 40,000 = 5.
  6. Interpretation: A ROCE of 66.67% shows efficient use of capital, and an interest coverage of 5 indicates the firm can meet its interest obligations five times over, reflecting good financial health.
  7. Hence, ROCE = 66.67% and Interest Coverage Ratio = 5.
Common mistake: Confusing net profit with PBIT while calculating ROCE

Concept tested: ROCE and Interest Coverage (Profitability & Solvency Ratios)

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