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FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies

A company has EBITDA of USD 40 million, interest expense of USD 30 million and capital expenditure of USD 20 million needed to maintain its assets. Which interpretation is most appropriate for a distress analyst?

EBITDA less maintenance capex is USD 20 million, below the USD 30 million interest bill, leaving a USD 10 million shortfall. The firm must refinance or sell assets to pay interest, which is a distress symptom. The headline EBITDA coverage of 1.33x is misleading because it ignores required capital spending.

  1. AInterest coverage of 1.33x on EBITDA looks adequate, so distress risk is low
  2. BAfter maintenance capex the firm cannot cover interest from operations, so it is a distress symptom despite the EBITDA coverage ratio above 1Correct
  3. CEBITDA exceeds interest, so the firm will be able to repay principal at maturity without refinancing
  4. DOnly the debt-to-equity ratio matters, so no conclusion can be drawn

Explanation

EBITDA minus capex equals USD 20 million, which is below USD 30 million of interest, leaving a USD 10 million shortfall. The firm must borrow, sell assets or issue equity to pay interest. The simple EBITDA/interest ratio of 1.33x hides this and so understates distress.

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