Deepvik Textiles has Rs 600 crore of floating-rate debt and rates rise by 200 basis points. Walk through the effect on interest, net income, interest cover and free cash flow, then on its cost of capital and enterprise value.

Interest rises from Rs 54 crore to Rs 66 crore, net income falls from Rs 49.5 crore to Rs 40.5 crore, -18.2%, and EBIT cover drops from 2.22x to 1.82x, under the 2.0x covenant. Free cash flow falls the same Rs 9 crore, to Rs 40.5 crore. On the valuation side the after-tax cost of debt rises to 8.25% and, with the cost of equity up too, WACC moves from 10.4% to 12.1%, cutting enterprise value by about 19% and equity by about 37%.

A household with a floating-rate home loan feels a rate rise in the next EMI: the same salary, a bigger interest line, less left over. Deepvik is that household with a Rs 600 crore loan. Interest goes from 9% of Rs 600 crore, Rs 54 crore, to 11%, Rs 66 crore; the extra Rs 12 crore comes off profit before tax, saves Rs 3 crore of tax, and cuts net income by Rs 9 crore. Walk it: EBITDA Rs 150 crore less depreciation Rs 30 crore is EBIT Rs 120 crore. Before, interest of Rs 54 crore leaves Rs 66 crore, tax Rs 16.5 crore, net income Rs 49.5 crore. After, interest of Rs 66 crore leaves Rs 54 crore, tax Rs 13.5 crore, net income Rs 40.5 crore. The rate moved 22%; net income moved 18%, because interest already consumed most of EBIT.

The covenant is where this bites first. EBIT cover was Rs 120 crore over Rs 54 crore, 2.22x; it is now Rs 120 crore over Rs 66 crore, 1.82x, below the 2.0x the loan requires. Deepvik breaches its covenant at any rate above 10%, so a 200 basis point move takes it from compliant to in default without a rupee of operating performance changing. Free cash flow after capex follows net income because depreciation and capex cancel: Rs 49.5 crore before, Rs 40.5 crore after, and interest now absorbs 44% of EBITDA against 36%.

In a DCF, interest does not appear in the cash flow at all; unlevered free cash flow is EBIT after tax plus depreciation less capex, Rs 90 crore, the same before and after. The rate rise reaches the valuation through the discount rate: the after-tax cost of debt goes from 6.75% to 8.25%, and the cost of equity rises with the risk-free rate, here from 14% to 16%, so WACC at 50:50 weights moves from 10.38% to 12.12%. Treating Rs 90 crore as a perpetuity growing 3%, enterprise value goes from Rs 1,257 crore to Rs 1,016 crore, 19% lower. Debt is still Rs 600 crore, so equity takes the whole fall: Rs 657 crore to Rs 416 crore, 37%.

The two channels are different in kind and candidates mix them up. The statements channel is about Deepvik's own floating debt: a fixed-rate borrower would see no change in interest or cover. The valuation channel hits every company, fixed or floating, because the rate rise lifts the return investors demand. Had only the cost of debt moved and the cost of equity stayed at 14%, WACC would be 11.13% and enterprise value Rs 1,141 crore; most of the valuation damage comes from the equity side. The limit of the sketch is the perpetuity: a real model would also ask whether higher rates slow Deepvik's customers, which hits EBITDA itself.

Two things, before the next rate decision. Fix the rate on part of the debt: a swap on Rs 600 crore at a cost of, say, 50 basis points would have capped interest at Rs 57 crore and kept cover at 2.11x. And open the covenant conversation with the lenders early, with a plan to reduce debt from free cash flow, because a breach discovered at the test date is negotiated from weakness. The lesson the interviewer is after is the chain itself: rate to interest to profit to cover to cash, then rate to discount rate to value, with the numbers at each step.