medium · Corporate Credit Analysis covenants
A company has $100 million of annual EBITDA and $20 million of annual interest expense.
If interest rates rise such that the interest expense increases to $40 million, and EBITDA remains flat, how does the 'EBITDA / Interest' coverage ratio change in terms of credit risk assessment?
- The risk decreases because the higher interest expense creates a larger tax shield, meaningfully increasing after-tax net income and retained cash flow.
- The ratio drops from 5.0x to 2.5x, moving the company from a comfortable 'investment grade' buffer to a 'speculative grade' buffer.
- The risk remains the same because the total outstanding debt balance itself has not increased, only the rate applied to it.
- The ratio remains 5.0x because coverage is always calculated using the original 'Opening' interest rate locked in at issuance.
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