Question

Shore Health System is considering developing full-service imaging centers across its service area and plans to issue long-term debt to finance these centers. Before it meets with its investment bankers, it wants to estimate how much additional debt it can take on. Currently Springfield Health System has annual debt service payments of $7 million, and its cash flow available to meet debt service payments is $30 million per year. For its new debt issuance, it plans to issued fixed-rate debt for 30 years. It also assumes Fitch Rating Agency will assign it a BBB rating. Fitch's median debt service coverage ratio for BBB-rated large health care systems is 2.90X. The expected rate for a 30-year BBB rate long-term bond is 7%. Using Fitch's median debt service coverage ratio for a BBB-rated bond along with prior information, how much additional debt could Shore Healthtake on?

1. What is the projected debt service payments?
2. What is the projected additional debt service payments?
3. What is the projected additional debt borrowings that Shore can take on?

Answer 1

Solution:

a)Calculation of projected debt service payments

Debt service coverage ratio=Operating income/total debt service

In the given question,debt service coverage ratio Shore Healthtake is 2.90,thus projected debt service payments is;

=Operating income/Debt service coverage ratio

=$30 million/2.90

=$10.34 million

Thus,projected debt service payments for Shore Healthtake is $10.34 million.

b)Calculation of projected additional debt service payments

Additional debt service payments=Projected debt service payments-Current debt service payments

=$10.34 million-$7 million

=$3.34 million

c)Calculation of projected additional debt borrowings that Shore can take on:

Since the expected rate on additional debt is 7%,it means $3.34 million is 7% of additional debt,thus projected additional debt borrowings that Shore can take on is:

=$3.34 million/7%

=$47.71 million