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Hello Chris
Apollo Co took out a new loan on 1st January 20X6. This loan is carries an effective interest
rate of 8%. The initial proceeds of the loan are $2.5m, which is after paying issue costs of
$250k. The coupon rate on the loan is 6%. Apollo must keep to an interest cover ratio of
9 times under the arrangements made with the bank.
What operating profit must be maintained by Apollo in the year ended 31st December
20X6, in order to meet the minimum interest cover ratio specified by the bank?
A $1,350,000
B $1,800,000
C $450,000
D $1,980,0001. The answer is B.
2. The working shown in the kit is as follows:
-The finance cost in the profit or loss account will be based on the effective interest rate, so the charge will be $2.5m × 8% = $200,000. If the interest cover to be maintained is 9, then the minimum operating profit to be maintained must be $200 × 9 = $1.8m.3. My issue is that why when calculating interest expense, $2.5M has been used?
-As per IFRS 9, we should have deducted the $250K and then calculate the interest.4.Please locate where I am getting things wrong.
Thanks in advance.
Hi,
Your knowledge of IFRS 9 is correct with regards to deducting the issue costs from the proceeds of the loan. Where you are going wrong is that it says in the question that the $2.5m are the net proceeds, so the issue costs have already been deducted.
Effectively, the loan is for $2.75m and the issue costs are $250k, which when net against each other give the $2.5m.
Hope that clears it up.
Thaks
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