Chartered Financial Analyst (CFA) Level 1 Practice Exam

What does EBITDA interest coverage indicate?

1. The margin by which EBITDA exceeds total liabilities

2. The ability to pay interest from earnings before interest, taxes, depreciation, and amortization

3. The ratio of net income to debt obligations

4. Financial health based on total revenue

The correct answer is: The ability to pay interest from earnings before interest, taxes, depreciation, and amortization

EBITDA interest coverage is a financial metric that assesses a company's ability to meet its interest obligations using its earnings before interest, taxes, depreciation, and amortization (EBITDA). This ratio is calculated by dividing EBITDA by the interest expenses incurred during a specific period. A higher EBITDA interest coverage ratio indicates a stronger capability to pay interest from operational earnings, which reflects financial stability and lower risk for lenders and investors. This measure is particularly important for lenders because it shows how easily a firm can generate sufficient earnings to cover its interest payments, thus providing insight into the firm's operational efficiency and liquidity. Therefore, answer B accurately captures the essence of what EBITDA interest coverage indicates. Other options discuss different aspects of financial metrics that do not relate directly to the specific purpose of the EBITDA interest coverage ratio. For instance, options referencing total liabilities or net income do not focus on the operational capacity to manage interest payments, while a mention of total revenue fails to consider the expenses and specific earnings characteristics that EBITDA addresses.