CFA Level I · CFA Level I Exam · Topics in Long-Term Liabilities and Equity
A firm has a covenant requiring a debt-to-EBITDA ratio of no more than 3.0x. Debt is 540 million and EBITDA is 200 million. Management is considering a one-time 30 million impairment charge (not in EBITDA computation per the loan agreement) and a 40 million repayment of debt from cash. After the repayment, the ratio is closest to:
The ratio after repayment is about 2.5x. Debt falls from 540 million to 500 million, and EBITDA stays at 200 million because the impairment is excluded under the loan agreement. Dividing 500 by 200 gives 2.5x, comfortably inside the 3.0x covenant limit.
- A2.5xCorrect
- B2.7x
- C3.0x
Explanation
After repayment debt = 540 - 40 = 500. Ratio = 500/200 = 2.5x. The current ratio is 2.7x, so the firm starts at 2.7x (540/200) and improves. The 3.0x figure is the covenant limit, and the impairment does not alter EBITDA under the agreement.
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