Question on Interest Coverage.



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Assume you are a banker advising a client with a Debt/Equity ratio of 5x. The client's interest coverage is 1.3x and they are expecting a 10% decrease in operating income next year. Their current interest expense is Rs.10 crores (100 million). How much new debt can your client safely take @10% interest without going bankrupt?

If the interest coverage is 1.3x of interest expense of 10 crore, the op. income should be 13 crore and a 10% reduction will make the Op income to 11.7 crore which means the interest coverage can be further reduced and may not get new debt. However, your answer is 20 million and I do not understand this. Please explain for my better understanding

1 Answer(s)


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At present operating income is 1.3 times of present interest expense (10*1.3 = 13 crore), now in coming year it would decrease by 10% as per question hence it would become 11.7 crore(13*.90 = 11.7).
Now how much more interest can the company bear can be worked out
which is ==>> 11.7 - 10 = 1.7crore.

now to pay up to 1.7 crore we can take this much loan@10%
1.7/10 * 100 = 17 crore.