You are evaluating the bonds of a below-investment-grade borrower at a low point
in its business cycle. You have many factors to consider, including the terms of
the company’s bank lending facilities. The contract creating a bank lending
facility such as an unsecured line of credit typically has clauses known as covenants.
These covenants place restrictions on what the borrower can do. The company will
be in breach of a covenant in the lending facility if the interest coverage ratio,
EBITDA/interest, calculated on EBITDA over the four trailing quarters, falls below 2.0.
EBITDA is earnings before interest, taxes, depreciation, and amortization. Compliance
with the covenants will be checked at the end of the current quarter. If the covenant
is breached, the bank can demand immediate repayment of all borrowings on the
facility. That action would probably trigger a liquidity crisis for the company. With a
high degree of confidence, you forecast interest charges of $25 million. Your estimate
of EBITDA runs from $40 million on the low end to $60 million on the high end.
3
Address two questions (treating projected interest charges as a constant):
1. If the outcomes for EBITDA are equally likely, what is the probability that
EBITDA/interest will fall below 2.0, breaching the covenant
AASHIKAJAINAJ123@GMAIL.COMBeginner
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