Question

How could a revaluation of a non-current asset minimise or loosen the effects of a restrictive debt covenant?

Answer 1

It is not unusual for a restriction to be imposed by lenders upon borrowers that restricts the level of debt that a borrowing company may attract. This limitation may be based on some proportion of total assets (Whittred and Zimmer, 1986). Increasing the book value of assets through a revaluation will decrease the debt to asset ratio, thereby potentially loosening the effects of a debt restriction. Whittred and Zimmer (1986), however, point out that it is quite common that the debt contracts will restrict the ability of the firm to undertake revaluations for the purposes of the debt covenant. For example, it is quite common that only revaluations that are based on valuations given by valuers approved by the debt holders, or their trustee, may be included in the debt to asset ratio calculation.