Chartered Financial Analyst (CFA) Level 1 Practice Exam

To calculate debt payment, which formula should be used?

1. CFO / Cash paid for long-term debt repayment

2. CFO / total debt

3. CFO / interest expense

4. CFO / current liabilities

The correct answer is: CFO / Cash paid for long-term debt repayment

The formula to calculate debt payment focuses on how effectively a company can use its cash flow from operations (CFO) to service its debt obligations. The most appropriate choice is the one that relates CFO to the cash paid for long-term debt repayment. This ratio is valuable as it provides insight into the relationship between the cash generated by the business and its ability to manage its debt responsibilities. Using cash flow from operations divided by cash paid for long-term debt repayment indicates how many times a company can cover its long-term debt obligations with its generated cash flow. This metric is important for assessing the financial health and stability of a company in relation to its debt load. It highlights the company's ability to generate sufficient cash to meet its long-term financial commitments. The other options do not capture the same direct relationship between operating cash flow and specific debt repayment funds: - Total debt doesn’t reflect the immediate capacity to pay debt, but rather the total amount of debt outstanding. - Interest expense provides insight into the cost of debt but does not directly relate to cash flow adequacy for principal repayments. - Current liabilities encompass all short-term obligations and do not specifically focus on the relationship with long-term debt repayment. Thus, using CFO in relation to cash paid for long-term debt gives