I got confused by the apparent use of interest coverage and long-term debt-to-equity definitions. In the Schweser example starting on page 169 (book3) 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 as well as in the Schweser books (SS8) interest coverage seems to be defined a (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 Schweser example on page 155 (book 3) 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?
there is another point of view that if the deferred taxes are increasing on an ongoing basis, year on year - it should be treated as equity. I think the usage of DTL in the LTD/E formula is a case-by-case basis decision. And usually when it comes to things like these - if the CFAI provides you with DTL in a question involving calc. of this ratio, then include it… bcos they mean for you to include it.
Yeah, seems like it’s down to this. Thanks.