Would you lend $12m to this distributor?
A US parts distributor needs $12m. The four-year loan charges 10% on opening principal and repays 10% of original principal each year, plus the remaining balance at maturity. Base EBITDA is $5m. Downside EBITDA is $3m.
“How much could I lose if things get bad?” (opens the source)
The question
All figures are in USD millions. This is a fictional US loan. In the base case, cash taxes are $0.5m, maintenance capex is $0.6m and working capital increases by $0.4m. In the downside, taxes fall to $0.2m. The other two cash uses stay fixed. The exercise requires at least 1.10× downside coverage. The loan agreement tests gross debt after the scheduled payment against full-year EBITDA at the first fiscal year-end. Above 3.50× breaches.
“Make a loan decision and explain what would change it.”
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A strong answer, step by step
Open each step in turn. This is one strong answer, not the only one.
Step 1: Convert earnings to cash
What would you do here? Open the move you’d make.
Deduct taxes, maintenance and working capital
The strong move. Cash conversion falls from 70% to 60%.
Use all EBITDA
Tempting, but it misses something. The distributor needs cash to maintain equipment and finance inventory and invoices.
See how a strong candidate says it
“Base deductions of $0.5m, $0.6m and $0.4m leave $3.5m. In the downside, taxes fall to $0.2m and the other uses stay fixed. Cash available falls to $1.8m.”
Why it works: Cash conversion falls from 70% to 60%.
Step 2: Test the requested loan
What would you do here? Open the move you’d make.
Approve on the base case
Tempting, but it misses something. Base coverage is 1.46×. The downside still fails both exercise tests.
Decline the $12m request
The strong move. The downside fails the 1.10× underwriting screen and projects a covenant breach.
See how a strong candidate says it
“Downside coverage is $1.8m ÷ $2.4m = 0.75×. The fictional agreement tests actual gross debt after the scheduled payment at first fiscal year-end divided by full-year EBITDA without add-backs. Above 3.50× breaches. Assuming payment, downside leverage is $10.8m ÷ $3m = 3.60×.”
Why it works: The downside fails the 1.10× underwriting screen and projects a covenant breach.
Step 3: Revise the structure
What would you do here? Open the move you’d make.
Replace $4m of debt with funded equity
The strong move. A smaller loan clears both exercise tests.
Raise the interest rate
Tempting, but it misses something. Higher interest makes the cash shortfall larger.
See how a strong candidate says it
“At $8m, downside coverage is $1.8m ÷ $1.6m = 1.125×. Year-end debt of $7.2m gives 2.40× leverage and 1.10× headroom.”
Why it works: A smaller loan clears both exercise tests.
Step 4: Check loss if the borrower defaults
What would you do here? Open the move you’d make.
Use projected year-end debt
Tempting, but it misses something. The scheduled principal was still outstanding when the borrower defaulted.
Use the balance before the missed payment
The strong move. Recovery uses cash from collateral after costs and the claim at the time of default.
See how a strong candidate says it
“In a separate default immediately before the first payment, net sale proceeds are $7m − $0.7m = $6.3m. The first lien has priority. Principal recovery is 52.50% on $12m and 78.75% on $8m.”
Why it works: Recovery uses cash from collateral after costs and the claim at the time of default.
The answer, in short
- Decision
- Decline $12m. Consider $8m with funded equity.
- Because
- The smaller loan clears the Year 1 downside screens.
- What would change it
- Require $4m of equity at close and verify liquidity and the maturity plan.
Reset to $12m. What is the maximum loan under the 1.10× downside coverage screen?
Common traps
- Applying a covenant to projected debt without stating the scheduled payment assumption.
Check your answer
- I bridged EBITDA to cash.
- I used interest and principal in coverage.
- I stated the covenant date and threshold.
- I used the default-date claim for recovery.
Last reviewed Nov 10, 2026