Objectives

Section Learning Objectives

1.1

Why Debt Modeling Matters

📖 Key Concept

Debt is one of the most critical components in financial modeling. It affects:
• Income Statement: Interest expense reduces net income
• Balance Sheet: Debt balances and cash positions
• Cash Flow Statement: Debt drawdowns and repayments
• Valuation: Cost of capital and enterprise value bridge

🎯 Real-World Application

When building an Leveraged Buyout (LBO) model, M&A model, or even a simple DCF, understanding debt structure is essential. Companies rarely operate with just one type of debt - they typically have multiple tranches with different terms, rates, and maturities.

Example: Typical Indian Corporate Debt Structure
An Indian manufacturing company might have:
• Cash Credit / Working Capital Facility: ₹200 Cr committed, currently drawn ₹60 Cr
• Term Loan (Fund-based): ₹300 Cr, 5-year amortizing, linked to Repo Rate + 2.00%
• Non-Convertible Debentures (NCDs): ₹500 Cr, 7-year bullet, fixed 9.50% coupon
• External Commercial Borrowing (ECB): $50M, 5-year, SOFR + 1.50%
1.2

Types of Debt Instruments

🔄 Revolving Credit Facility (RCF)

Flexible borrowing up to a committed limit

  • Like a credit card - borrow and repay repeatedly
  • Commitment fee on undrawn amount
  • Floating rate — INR loans: RBI Repo Rate + spread; USD loans: SOFR + spread
  • Indian equivalent: Cash Credit (CC) / Working Capital Facility
  • Used for: Working capital, emergencies
Excel Logic:
Revolver = MAX(0, Required Cash - Available Cash)

📅 Term Loans

Fixed borrowings with scheduled repayments

  • Term Loan A (TLA): Amortizing over 5-6 years
  • Term Loan B (TLB): Minimal amortization, bullet at end
  • Floating rate — INR: Repo Rate + spread; USD: SOFR + spread
  • Used for: Acquisitions, capex, project finance
Excel Logic:
End Balance = Beg - Mandatory Amort - Optional Prepay

📜 Bonds / Notes

Long-term debt securities

  • Fixed coupon rate - predictable interest
  • Bullet maturity - principal due at end
  • Indian equivalent: Non-Convertible Debentures (NCDs)
  • Longer tenor: 5-10 years typical
  • Prepayment penalties - call protection
Excel Logic:
Interest = Principal × Coupon Rate
No scheduled principal payments

🏗️ Mezzanine / Subordinated

Junior debt with equity-like features

  • Higher yield - 14-22% typically (Indian market)
  • PIK interest - paid in kind (added to principal)
  • Equity kickers - optionally convertible debentures (OCDs)
  • Used in: Growth financing, promoter funding
PIK Interest:
End Balance = Beg × (1 + PIK Rate)

📖 Deep Dive: Understanding Each Debt Type

Click through each section below to understand how each debt type works in practice, with real-world Indian examples and step-by-step solutions.

🔄 Revolving Credit Facility — Cash Credit in India

A Revolving Credit Facility (RCF) is a flexible borrowing arrangement where a company can draw and repay funds repeatedly up to a pre-approved limit. In India, this is most commonly known as a Cash Credit (CC) facility or Working Capital Facility. Banks sanction a limit based on the company's working capital requirements (typically calculated using the Tandon Committee method or Nayak Committee norms). The borrower only pays interest on the amount actually drawn, not the sanctioned limit. Additionally, banks charge a commitment fee on the undrawn portion to compensate for keeping the facility available.
The interest rate on a CC facility is floating — linked to the RBI Repo Rate plus a negotiated spread. Under RBI's External Benchmark Based Lending Rate (EBLR) system, the rate is reset at least quarterly. This means the company's borrowing cost changes whenever the RBI revises the Repo Rate.
📝 Worked Example

Calculating Total Cost of a Cash Credit Facility

Scenario: Larsen & Toubro (L&T) has a ₹500 Crore Cash Credit facility with State Bank of India.
• Sanctioned limit: ₹500 Cr
• Average drawing during Q1 FY2025: ₹320 Cr
• Benchmark: RBI Repo Rate = 6.50%
• Spread negotiated with SBI: 2.00%
• Commitment fee on undrawn amount: 0.375% per annum

Question: What is the total quarterly cost (interest + commitment fee) for L&T for Q1 FY2025?
1
Calculate the effective interest rate
Interest Rate = RBI Repo Rate + Spread
Interest Rate = 6.50% + 2.00% = 8.50% per annum
2
Calculate interest expense for Q1 (3 months)
Interest = Principal Drawn × Rate × (Time in months / 12)
Interest = ₹320 Cr × 8.50% × (3 / 12)
Interest = ₹320 Cr × 0.02125
Interest = ₹6.80 Crore
3
Calculate the undrawn amount
Undrawn Amount = Sanctioned Limit - Drawn Amount
Undrawn Amount = ₹500 Cr - ₹320 Cr = ₹180 Crore
4
Calculate commitment fee for Q1
Commitment Fee = Undrawn × Fee Rate × (3 / 12)
Commitment Fee = ₹180 Cr × 0.375% × (3 / 12)
Commitment Fee = ₹180 Cr × 0.0009375
Commitment Fee = ₹0.16875 Crore ≈ ₹0.17 Crore
5
Calculate total quarterly cost
Total Q1 Cost = Interest + Commitment Fee
Total Q1 Cost = ₹6.80 Cr + ₹0.17 Cr = ₹6.97 Crore
Total Q1 Cost = ₹6.97 Crore

📅 Term Loans — Amortizing Debt for Capex & Growth

A Term Loan is a lump-sum borrowing with a fixed repayment schedule over a specified tenure. In India, term loans are widely used for funding capital expenditure (capex), acquisitions, and project finance. Indian banks offer term loans linked to the RBI Repo Rate (for INR loans) or SOFR (for USD-denominated ECBs). The repayment typically follows an amortization schedule — either equal principal installments (EPI) or equated monthly installments (EMI).
Unlike a revolver, once you repay a term loan, you cannot re-borrow that amount. Term loans in India are usually secured against the assets being financed (plant, machinery, property). The loan agreement specifies mandatory principal repayment (amortization), and sometimes allows optional prepayment (cash sweep) subject to a prepayment penalty.
📝 Worked Example

Building a Term Loan Amortization Schedule

Scenario: Tata Steel takes a ₹400 Crore term loan from HDFC Bank for a new plant.
• Principal: ₹400 Cr
• Tenure: 5 years (FY2025 to FY2029)
• Interest Rate: Repo Rate (6.50%) + Spread (2.50%) = 9.00% p.a.
• Repayment: Equal principal installments (20% per year = ₹80 Cr/year)
• No optional prepayment

Question: Build the annual amortization schedule showing beginning balance, interest, principal repayment, and ending balance for each year.
1
Identify the key parameters
Principal = ₹400 Cr | Rate = 9.00% p.a. | Tenure = 5 years
Annual Principal Repayment = ₹400 Cr / 5 = ₹80 Crore/year
2
Year 1 (FY2025) Calculation
Beginning Balance = ₹400.00 Cr
Interest = ₹400.00 Cr × 9.00% = ₹36.00 Cr
Principal Repayment = ₹80.00 Cr
Ending Balance = ₹400.00 - ₹80.00 = ₹320.00 Cr
3
Year 2 (FY2026) Calculation
Beginning Balance = ₹320.00 Cr
Interest = ₹320.00 Cr × 9.00% = ₹28.80 Cr
Principal Repayment = ₹80.00 Cr
Ending Balance = ₹320.00 - ₹80.00 = ₹240.00 Cr
4
Year 3 (FY2027) Calculation
Beginning Balance = ₹240.00 Cr
Interest = ₹240.00 Cr × 9.00% = ₹21.60 Cr
Principal Repayment = ₹80.00 Cr
Ending Balance = ₹240.00 - ₹80.00 = ₹160.00 Cr
5
Year 4 (FY2028) Calculation
Beginning Balance = ₹160.00 Cr
Interest = ₹160.00 Cr × 9.00% = ₹14.40 Cr
Principal Repayment = ₹80.00 Cr
Ending Balance = ₹160.00 - ₹80.00 = ₹80.00 Cr
6
Year 5 (FY2029) — Final Year
Beginning Balance = ₹80.00 Cr
Interest = ₹80.00 Cr × 9.00% = ₹7.20 Cr
Principal Repayment = ₹80.00 Cr
Ending Balance = ₹80.00 - ₹80.00 = ₹0 (Fully Repaid)
7
Total Cost Summary
Total Principal Repaid = ₹400.00 Cr
Total Interest Paid = ₹36.00 + ₹28.80 + ₹21.60 + ₹14.40 + ₹7.20 = ₹108.00 Cr
Total Cost of Loan = ₹400.00 + ₹108.00 = ₹508.00 Crore
Total Interest Over 5 Years = ₹108.00 Crore

📜 Bonds / Non-Convertible Debentures (NCDs)

Non-Convertible Debentures (NCDs) are the Indian equivalent of corporate bonds. They are long-term debt instruments issued by companies to raise funds from the public or institutional investors. NCDs carry a fixed coupon rate and have a bullet maturity — meaning the principal is repaid in full at maturity, with no scheduled amortization during the tenure. This makes interest calculation straightforward: the same fixed amount is paid every period.
In India, NCDs are regulated by SEBI and must be rated by credit rating agencies (CRISIL, ICRA, CARE, etc.). Companies like Tata Motors, Reliance Industries, and HDFC Ltd regularly issue NCDs. They are popular with investors because they offer higher returns than bank fixed deposits. For the issuing company, NCDs provide long-term funding without the burden of periodic principal repayment, though the entire principal comes due at once (bullet risk).
📝 Worked Example

Calculating Total Cost of an NCD Issuance

Scenario: Reliance Industries issues ₹1,000 Crore of NCDs.
• Face value: ₹1,000 per debenture
• Coupon rate: 9.25% p.a. (paid annually)
• Tenure: 7 years (bullet maturity)
• Issue expenses (underwriting, legal, rating fees): 1.50% of issue size
• Net proceeds to company = Issue size - Issue expenses

Question: Calculate (a) annual interest expense, (b) total interest over 7 years, (c) net proceeds, and (d) effective cost to company.
1
Calculate annual interest expense (coupon payment)
Annual Interest = Face Value × Coupon Rate
Annual Interest = ₹1,000 Cr × 9.25% = ₹92.50 Crore/year
2
Calculate total interest over 7 years
Total Interest = Annual Interest × Number of Years
Total Interest = ₹92.50 Cr × 7 = ₹647.50 Crore
3
Calculate issue expenses and net proceeds
Issue Expenses = ₹1,000 Cr × 1.50% = ₹15.00 Crore
Net Proceeds = ₹1,000 Cr - ₹15.00 Cr = ₹985.00 Crore
4
Calculate total amount to be repaid at maturity
Principal repayment at maturity (Year 7) = ₹1,000 Crore
(NCDs are bullet repayment — entire principal due at end)
5
Calculate effective cost to the company
Total Outflow = Total Interest + Principal Repayment + Issue Expenses
Total Outflow = ₹647.50 Cr + ₹1,000.00 Cr + ₹15.00 Cr = ₹1,662.50 Crore

Effective Cost Rate (approximate) ≈ Total Interest / Net Proceeds / Years
= (₹647.50 + ₹15.00) / ₹985.00 / 7 × 100 ≈ 9.60% per annum
(This is slightly higher than 9.25% coupon due to issue expenses)
Effective Cost ≈ 9.60% p.a. (vs. 9.25% coupon)

🏗️ Mezzanine / Subordinated Debt — PIK & OCDs in India

Mezzanine debt sits between senior debt and equity in the capital structure. It carries the highest interest rate (14-22% in India) because it is the riskiest form of debt — in case of insolvency, mezzanine lenders are paid last among all creditors. In India, this category includes Optionally Convertible Debentures (OCDs), Compulsorily Convertible Debentures (CCDs), and subordinated unsecured loans.
A unique feature of mezzanine debt is PIK (Pay-In-Kind) interest. Instead of paying interest in cash each period, the interest is added to the principal balance. This means the debt grows over time — a concept called "compounding debt." While this conserves cash for the company in the short term, it results in a much larger repayment at maturity. For financial modeling, PIK debt requires tracking a growing balance rather than a declining one.
📝 Worked Example

Calculating PIK Interest and Compounding Debt Balance

Scenario: A growth-stage Indian fintech company raises ₹150 Crore through Optionally Convertible Debentures (OCDs) from a private credit fund.
• Principal: ₹150 Cr
• PIK Interest Rate: 16% per annum
• Tenure: 3 years
• Interest is Pay-In-Kind (PIK) — added to principal, not paid in cash
• No cash interest payments during the tenure

Question: Calculate the PIK interest and ending balance for each year. What is the total amount due at maturity?
1
Understand the PIK mechanism
PIK Interest = Beginning Balance × PIK Rate
Ending Balance = Beginning Balance + PIK Interest
(No cash payment — interest compounds into the principal)
2
Year 1 Calculation
Beginning Balance = ₹150.00 Cr
PIK Interest = ₹150.00 Cr × 16.00% = ₹24.00 Cr
Ending Balance = ₹150.00 + ₹24.00 = ₹174.00 Cr
Cash Interest Paid = ₹0
3
Year 2 Calculation
Beginning Balance = ₹174.00 Cr
PIK Interest = ₹174.00 Cr × 16.00% = ₹27.84 Cr
Ending Balance = ₹174.00 + ₹27.84 = ₹201.84 Cr
Cash Interest Paid = ₹0
4
Year 3 Calculation
Beginning Balance = ₹201.84 Cr
PIK Interest = ₹201.84 Cr × 16.00% = ₹32.29 Cr
Ending Balance = ₹201.84 + ₹32.29 = ₹234.13 Cr
Cash Interest Paid = ₹0
5
Total Amount Due at Maturity
Original Principal = ₹150.00 Cr
Total PIK Interest Accrued = ₹24.00 + ₹27.84 + ₹32.29 = ₹84.13 Cr
Total Amount Due at End of Year 3 = ₹234.13 Crore

Alternative check: ₹150 Cr × (1.16)³ = ₹150 × 1.560896 = ₹234.13 Cr ✓
Total Due at Maturity = ₹234.13 Crore (₹150 Cr principal + ₹84.13 Cr PIK interest)
1.3

Debt Seniority & Payment Waterfall

📊 Seniority Pyramid - Who Gets Paid First?

2
Senior Unsecured NCDs / Bonds
No collateral, but senior claim on assets
3
Subordinated Debt / Optionally Convertible Debentures
Junior to senior debt, higher interest rate
⚠️ Important for Modeling

Cash Flow Waterfall: In financial models, cash typically flows to debt in order of seniority:
1. Pay interest on all debt
2. Mandatory amortization on senior debt
3. Optional prepayments (cash sweep) - usually highest cost debt first
4. Equity distributions (only after debt is satisfied)

1.4

Key Debt Terms & Covenants

📋 Essential Debt Terminology

Term Definition Example
Principal The amount borrowed ₹500 Crore
Interest Rate / Coupon Cost of borrowing (annual %) INR: Repo Rate + 200 bps
USD: SOFR + 150 bps
Maturity Date when principal is due March 31, 2030
Amortization Scheduled principal repayments 5% per year
Spread / Margin Additional rate over benchmark +200 basis points
Commitment Fee Fee on undrawn facility 0.25% per year
Prepayment Penalty Fee for early repayment 1-2% of prepaid amount

🛡️ Debt Covenants

Restrictions and requirements imposed by lenders

Financial Covenants
  • Debt/EBITDA ≤ 4.0x
  • Interest Coverage ≥ 3.0x
  • Fixed Charge Coverage ≥ 1.1x
  • Min Equity / Max Debt
Negative Covenants
  • No additional debt
  • No dividends above limit
  • No asset sales above threshold
  • No change of control
1.5

Indian Context: Interest Rate Benchmarks

🇮🇳 Understanding India's Dual Benchmark System

In India, the benchmark used for floating rate loans depends on the currency of the loan. The RBI mandates that all floating rate rupee loans be linked to an external benchmark.

📊 Benchmark Comparison: INR vs. USD Loans

Feature INR Loans (Rupee) USD Loans (Foreign Currency)
Base Benchmark RBI Repo Rate (or T-Bill yield) SOFR (Secured Overnight Financing Rate)
Formula Repo Rate + Spread SOFR + Spread
Currency ₹ INR $ USD
Regulator Reserve Bank of India (RBI) RBI guidelines + Global markets
Rate Reset At least once every 3 months (RBI mandate) Typically quarterly

🏦 RBI-Approved External Benchmarks for INR Loans

Banks must link floating rate rupee loans to one of these RBI-approved benchmarks:

  • RBI Repo Rate — Most commonly used (currently 6.50%). The rate at which RBI lends to commercial banks.
  • 91-day / 182-day Treasury Bill Yield — Short-term government security yields published by RBI.
  • FBIL Benchmarks — Any benchmark published by Financial Benchmarks India Pvt Ltd.
Example — INR Floating Rate Calculation:
Total Interest Rate = Repo Rate (6.50%) + Spread (2.00%) = 8.50%
If RBI raises Repo Rate to 7.00% → New rate = 7.00% + 2.00% = 9.00%

💵 USD-Denominated Loans: SOFR in India

For External Commercial Borrowings (ECBs) in USD, Indian companies use SOFR as the benchmark — same as global markets.

Real-World Examples — Indian Companies Using SOFR:

• State Bank of India (SBI) — Raised $1.25 billion at SOFR + 92.5 bps
• IIFL Finance — Raised $175 million at SOFR + 200 bps
• Piramal Capital — Raised $100 million at SOFR + 200 bps
💡 Key Points for Indian Businesses

1. Mandatory Reset (INR): RBI mandates that floating interest rates on rupee loans must be reset at least once every 3 months based on the external benchmark.

2. Spread is Negotiable: While the benchmark (Repo Rate or SOFR) is publicly published, the "spread" added by the bank is negotiable based on credit rating, financial health, and loan tenure.

3. ECB Guidelines: Dollar-denominated borrowings (ECBs) are regulated by RBI and subject to external borrowing limits and reporting requirements.

Summary

Key Takeaways

  • Revolvers / Cash Credit provide flexible liquidity like a credit card
  • Term loans have scheduled amortization; NCDs typically don't
  • Seniority determines payment priority in distress
  • Covenants protect lenders and constrain borrowers
  • Debt schedules must track multiple tranches separately
  • Indian benchmarks: INR loans use RBI Repo Rate + spread; USD loans use SOFR + spread
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