(3) INTEREST COVERAGE RATIO: The ability of a firm to use debt in the capital structure may be judged in terms of interest coverage ratio. It is the ratio or relation between operating profit and interest. Higher the ratio, greater is the certainty of meeting interest payment. If the ratio is lower, the firm may not be able to pay interest in future. EBIT-EPS analysis is a good supporting tool in determining a suitable capital structure. Cash flow under adverse situation should be examined in order to determine the debt capacity. A high debt-equity ratio may not be risky if the company has the ability to generate adequate cash flows. It may be possible to increase the debt until cash flows equal to the risk set out by debt capital. With the help of information available, a range can be determined for an optimum level of debt in the capital structure. Illustration 3: BEST Ltd, a profit making company has paid up capital of Rs. 100 lakhs consisting of 10 lakhs equity shares of Rs. 10 each. Currently it is earning an annual pre-tax profit of Rs. 60 lakhs. The company's shares are listed and quoted in the range of Rs. 50 to Rs. 80. The management wants to diversity production and has approved a project which will cost Rs. 50 lakhs and it is expected to yield a pre-tax income of Rs. 40 lakhs per annum. To raise this additional capital, the following options are under consideration of the management. 52 (a) To issue equity capital for the entire additional amount. It is expected that the new shares (face value Rs. 10) can be sold at a premium of Rs. 15. (b) To issue 16% non-convertible debenture of Rs. 100 each for the entire amount. (c) To issue equity capital for Rs. 25 lakhs (face value Rs. 10) and 16% non-convertible debenture for the balance amount. In this case, the company can issue shares at a premium of Rs. 40 each. You are required to advise the management as to how the additional capital can be raised keeping in mind that the management wants to maximise the earning per share to maintain its goodwill. The tax rate applicable to the company is 30%