Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which metric evaluates a company's ability to pay interest using its funds from operations?

1. Return on Capital

2. FFO interest coverage

3. Dividends per share

4. Cash Flow per share

The correct answer is: FFO interest coverage

FFO interest coverage is a critical metric used to assess a company's capability to meet its interest obligations utilizing the funds generated from its operations. This ratio highlights the relationship between a company's funds from operations (FFO) and its interest expenses. By calculating how many times the company's operational cash flow can cover its interest expenses, it provides insight into financial stability and the ability to sustain borrowings without risking liquidity. This metric is particularly beneficial for investors and analysts since it focuses on cash flows derived from operations, rather than accounting earnings, providing a clearer picture of a company's operational efficiency in servicing debt. A higher ratio indicates a stronger ability to cover interest obligations, suggesting a lower risk of default, while a lower ratio may raise concerns about financial distress. The other metrics listed, such as return on capital, dividends per share, and cash flow per share, do not specifically measure a company's capacity to pay interest directly from operational cash flows. Instead, they may focus on overall profitability, shareholder returns, or aggregate cash generation and may not provide the same targeted insight regarding interest coverage.