Question

a) What is borrowing capacity of a project? How is it determined?

(b) Assume that the proposed investment in a project is $800 m. and its desired debt ratio is 60%. If the estimated operating cash flows are 650 m. and the target cash flow coverage ratio (α) is 1.25, will the project be able to reach its desired debt ratio?

Answer 1

a) The borrowing capacity is the maximum amount that is available for a company to  borrow. The factors that determine the borrowing capacity is the financials of the company , if the company already has too much debt, then raising further debt can be problematic for the company and as well the quality of the collateral that a company is ready to pledge against the loan amount. If the quality of the collateral is good, the loan amount can be increased.

b) Coverage ratio :

= Operating cash flows/ total debt = 1.25

= $800 / Total debt = 1.25

The total debt of the company is $640. As per the target cash flow coverage ratio, the total debt of the company is $640, which is not the desired level of debt as the desired level of debt should be 60% * $800m = $480m