CS Professional · Strategic Management and Corporate Finance · Project Evaluation
A project needs Rs 100 crore, funded by Rs 70 crore debt and Rs 30 crore equity. The sponsor's equity is Rs 30 crore. Lenders insist the debt-equity ratio not exceed 2:1 under their covenant. Which statement is correct?
The debt-equity ratio is 70 divided by 30, about 2.33 to 1, which exceeds the permitted 2 to 1. The project therefore breaches the covenant; it would need roughly Rs 33.33 crore of equity to comply.
- AThe project breaches the covenant because 70:30 is about 2.33:1Correct
- BThe project satisfies the covenant because 70:30 is below 2:1
- CThe project breaches the covenant because the ratio is 3:1
- DThe covenant cannot be tested without the interest rate
Explanation
Debt-equity = 70/30 = 2.33, which exceeds 2:1. To meet 2:1 with Rs 100 crore, debt would be about Rs 66.67 crore and equity Rs 33.33 crore. The interest rate is irrelevant to this ratio.
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