PIK Toggle Notes, Explained

Answer:
TLB mandatory amortization = $300M × 2% = $6M.

(a) Partial-PIK election:

• Cash interest: TLB $18M (300×6%) + PIK cash $6M (150×4%) = $24M.
• FCF after cash interest = $110M - $24M = $86M.
• After mandatory $6M, sweep = $80M.
• Total TLB paydown = $86M.
• End TLB = $300M - $86M = $214M.
• PIK balance: $150M × 1.05 = $157.5M.
• Total net debt = $214M + $157.5M = $371.5M.

(b) Full cash election:

• Cash interest: $18M + $13.5M (150×9%) = $31.5M.
• FCF after interest = $110M - $31.5M = $78.5M.
• After mandatory $6M, sweep = $72.5M.
• Total TLB paydown = $78.5M.
• End TLB = $300M - $78.5M = $221.5M.
• PIK balance unchanged = $150M.
• Total net debt = $221.5M + $150M = $371.5M.

Net debt is identical because the cash flow saved by PIKing ($7.5M) exactly equals the increase in PIK principal, leaving total leverage unchanged. However, the composition shifts: the PIK election reduces the senior TLB balance faster, improving senior credit metrics, but increases the junior PIK obligation that will accrue further or be paid at exit.

A sponsor may prefer the PIK election to preserve cash for operations or to accelerate paydown of a more restrictive senior tranche, but must weigh the growing PIK claim and its ultimate cost.

Follow-up pressure:

1. "Under what circumstances would a sponsor be forced to pay the PIK in cash rather than toggle? What might the credit agreement specify?"
2. "How would the presence of the PIK toggle affect the model's ability to handle the circular reference? Does the PIK interest create a new loop?"
3. "If the PIK note has a call protection schedule similar to high-yield bonds, how would that influence the sponsor's decision to PIK versus pay cash in the early years?"