The borrower and the proposed loan
For this exercise, cash available for debt service (CFADS) equals underwritten EBITDA minus capex, NWC investment and cash taxes. Debt service equals cash interest plus mandatory amortization. Use full-year interest on original debt for initial sizing. There are no fees, leases, revolver drawings or other debt. These are hypothetical credit-policy definitions, not universal market terms.
| Annual input, $m | Amount / assumption |
|---|---|
| Reported EBITDA | 18 |
| Management adjustment: prior litigation cost | +2; documented and nonrecurring for this exercise |
| Management adjustment: proposed future savings | +4; not implemented |
| Maintenance capex / operating NWC investment | 5 / 2 |
| Cash taxes | 3; fixed assumption for this exercise |
| Opening unrestricted cash / minimum cash | 6 / 4 |
| Interest / mandatory principal amortization | 10% / 5% of original debt annually |
| Requested original term debt | 70 |
| Committee leverage limit | 3.5x underwritten EBITDA |
| Committee cash coverage floor | 1.25x debt service |
- Determine management and underwritten EBITDA.
- Calculate the requested loan's leverage and debt-service coverage.
- Size debt using both constraints and identify the binding one.
- Assess the downside and list the evidence you would request before approval.
Underwrite each adjustment
Accept the $2m litigation adjustment only because the case explicitly stipulates evidence and nonrecurrence. Do not add the $4m proposed savings to base EBITDA: the cost has not been removed. In real diligence, even a documented historical expense requires scrutiny of future recurrence and associated cash payments.
Reported / management-adjusted / underwritten EBITDA
CFADS / requested debt service / coverage
Debt allowed by leverage / debt allowed by coverage / recommendation
Use your own notes or the writing space in the downloadable PDF.
Worked solution: coverage binds before leverage
The requested loan meets the stated leverage ceiling but fails the cash-coverage floor. The lower constraint implies approximately $53.33m debt before considering other risks. At that size, annual cash debt service is $8m and coverage is 1.25x. This is a screening ceiling under the exercise assumptions, not an approval recommendation.
Opening cash above the $4m minimum is $2m. It can provide a temporary cushion, but should not be capitalized into recurring CFADS or counted repeatedly across years.
| Calculation | Result |
|---|---|
| Management-adjusted EBITDA: 18 + 2 + 4 | $24m |
| Underwritten EBITDA: 18 + 2 | $20m |
| CFADS: 20 - 5 - 2 - 3 | $10m |
| Requested loan leverage: 70 / 20 | 3.50x |
| Requested annual debt service: 70 x (10% + 5%) | $10.5m |
| Requested coverage: 10 / 10.5 | 0.95x |
| Leverage-constrained debt: 20 x 3.5 | $70m |
| Coverage-constrained debt: 10 / (1.25 x 15%) | $53.33m |
Stress the loan before writing the memo
Now reduce underwritten EBITDA by 20% to $16m. Hold taxes and capex fixed at the given amounts and increase NWC investment to $3m. Use the $53.33m sized loan. Compute coverage, the annual cash shortfall and the effect on minimum cash. Assume cash movements occur evenly only for the purpose of estimating a rough runway.
Downside CFADS / debt service / coverage
Year-end cash / minimum cash breach
Diligence or structural change required
Use your own notes or the writing space in the downloadable PDF.
Downside answerOpen worked answer
CFADS becomes $16 - $5 - $3 - $3 = $5m. Debt service remains approximately $8m under the sizing convention. Coverage is 0.625x and the annual shortfall is $3m. Starting with $6m cash, year-end cash would be $3m, below the $4m minimum by $1m. The $2m usable cash cushion covers about eight months of a uniformly incurred $3m annual shortfall.
That runway is not a liquidity forecast: seasonality, payment dates and tax changes can move the breach much earlier or later. Ask for monthly cash data, a maturity schedule and customer-level collection history.
Write a conditional credit recommendation
- Distinguish a maintenance covenant calculation from the committee's sizing test; the legal agreement may define both differently.
- Ask whether maintenance capex has been understated or growth spending is necessary to preserve the forecast.
- Review collateral, security, ranking, maturity and restricted-payment terms alongside the numerical model.
- Do not replace diligence with a higher interest rate: more interest further reduces debt-service coverage.
Source notes
Sources support the underlying concepts. The worked cases, figures and examples are original teaching material with the assumptions stated in the resource.
Background on definitions and reconciliation of adjusted measures. All lending terms and committee constraints here are fictional and explicitly defined.
Questions about this resource
Are 3.5x leverage and 1.25x coverage market standards?
No. They are assumptions for this exercise. Actual limits and definitions depend on the borrower, lender, structure and credit agreement.
Why exclude forecast cost savings?
The case says they are not implemented. Treating them as current recurring cash earnings would overstate base debt capacity.
Build on the exercise
More practice for the gap you found.
Continue with longer underwriting cases, credit memos and interview simulations after working through this first cash-flow test.
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Private credit case: size the loan to cash
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Recommend a debt amount and explain the cash-flow and diligence limits behind it.