Two firms ABC and XYZ have applied for 5 year term loans from your bank. You can fund only 1 proposal. Interest Coverage ratio and Debt service coverage ratio of ABC are 3 and 0.8 respectively. These ratios stand at 2.8 and 2 respectively for XYZ. The banker will prefer None, because banker will seek more information about stock performance in the equity market to assess likely performnace over next 5 years XYZ, because it is better placed than ABC to meet ALL its repayment obligations for the current year ABC, because it has a higher interest coverage ratio
Question
Two firms ABC and XYZ have applied for 5 year term loans from your bank. You can fund only 1 proposal. Interest Coverage ratio and Debt service coverage ratio of ABC are 3 and 0.8 respectively. These ratios stand at 2.8 and 2 respectively for XYZ. The banker will prefer None, because banker will seek more information about stock performance in the equity market to assess likely performnace over next 5 years XYZ, because it is better placed than ABC to meet ALL its repayment obligations for the current year ABC, because it has a higher interest coverage ratio
Solution
The banker will prefer XYZ, because it is better placed than ABC to meet ALL its repayment obligations for the current year. This is because the Debt Service Coverage Ratio (DSCR) of XYZ is higher than ABC. DSCR is a measure of the cash flow available to pay current debt obligations. The higher this ratio is, the easier it is to obtain a loan. The Interest Coverage Ratio (ICR) of ABC is slightly higher than XYZ, but this ratio only measures the firm's ability to pay interest on its debt, not the ability to repay the principal. Therefore, considering both ratios, XYZ seems to be in a better position to meet all its repayment obligations for the current year.
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