A Required Debt Service Coverage Ratio Related to the Economic Value of the Asset Involved

Abstract

This paper aims to associate the Debt Service Coverage Ratio, DSCR , with the asset value involved. Usually, a minimum DSCR is defined by advisors for debt sizing of projects or as a reference for their risk assessment. Many times, such a definition depends on the investor’s industrial sector, such as infrastructure, power, etc. Since each project has its own market and risk features, the usual DSCR definition may over or undervalue those features, resulting tight or relaxed financial conditions in view of the project’s cash flow and risk. An analytical relation is found for relating a required ratio, DSCRr , to the value and risk of the asset involved, which also depends on the cost of debt and corporate tax. The relation is based on the financial criteria that the amount of debt associated to any asset should be smaller than its economic value with a high level of confidence. If the usual DSCR is greater than the DSCRr , the sponsor is sacrificing part of its profitability. If the usual DSCR is smaller than the DSCRr , the lenders are assuming a greater risk than the maximum recommended. The research results should not have relevant limitations. The comparison between usual DSCR and DSCRr could help sponsors and lenders reach an agreement on any financing, especially in project finance. This paper fulfils the need to associate the DSCR with the risk of the debtor and not only to the industrial sector where it operates.