Chartered Financial Analyst (CFA) Level 1 Practice Exam

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What aspect of financial health does EBITDA interest coverage provide insight into?

Short-term liquidity
Ability to cover interest expenses with earnings
Overall profitability
Investment strategy

The correct answer is: Ability to cover interest expenses with earnings

EBITDA interest coverage is a financial metric that assesses a company's ability to meet its interest obligations from earnings before interest, taxes, depreciation, and amortization (EBITDA). This calculation helps to understand how easily a company can pay interest on its outstanding debt, without being influenced by non-cash charges or tax obligations that could skew the view of available earnings. A higher EBITDA interest coverage ratio indicates that a company has a comfortable margin to cover its interest expenses, reflecting a lower risk of financial distress regarding its debt obligations. Conversely, a lower ratio may signal potential issues in meeting interest payments, which can be a red flag for investors and creditors. This metric is particularly focused on the relationship between earnings and interest expenses, rather than overall profitability, short-term liquidity, or investment strategy. Therefore, it is specifically aimed at evaluating a firm's financial health in terms of its capacity to manage interest payments effectively.