In order to calculate whether or not the covenant is breached every year, the proportion of debt to equity needs to be calculated each year. The debt will reduce by $3 million every year and the equity will increase by reserves every year. In order to calculate the increase in reserves every year, the forecast income statements need to be determined.
Forecast Income Statement ($000’s)
Workings
W1
Current operating profit before management service charge = $60,000,000 – ($12,000,000 + 22,000,000 + 4,000,000) = $22,000,000. This amount will grow by 8% every year.
