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?

  1. The risk decreases because the higher interest expense creates a larger tax shield, meaningfully increasing after-tax net income and retained cash flow.
  2. The ratio drops from 5.0x to 2.5x, moving the company from a comfortable 'investment grade' buffer to a 'speculative grade' buffer.
  3. The risk remains the same because the total outstanding debt balance itself has not increased, only the rate applied to it.
  4. The ratio remains 5.0x because coverage is always calculated using the original 'Opening' interest rate locked in at issuance.

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