Original Issue Discount (OID) on a Term Loan, Explained
The question
A sponsor arranges a $500M term loan that is issued at 97 (3% OID). The equity check is $300M. Transaction fees total $25M, and the target has no existing debt or excess cash. What is the implied enterprise value of the acquisition? Explain how the OID is accounted for in the sources & uses and how it subsequently impacts the P&L and cash flow.
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
Study explanation
Answer:
The loan's face value is $500M, but the cash proceeds received at close are only 97% × $500M = $485M. The $15M discount is the OID. In the sources & uses, the term loan source is recorded at $485M (the cash actually received), not $500M. Total sources = $485M (loan) + $300M (equity) = $785M. Uses = purchase of enterprise value + $25M fees. Therefore, EV = $785M - $25M = $760M.
The OID is effectively additional interest withheld upfront by the lender. On the balance sheet, the full $500M liability is recorded, with a $15M debt discount (contra-liability) that is amortized to interest expense over the loan's life, typically using the constant yield method. This amortization increases non-cash interest expense each year, reducing reported net income but not affecting cash interest.
The cash flow impact is neutral until maturity, when the full $500M principal is repaid.
Follow-up pressure:
- "Why would an issuer accept an OID? In what credit environment are OIDs common, and how do they affect the all-in yield for the lender?"
- "If the loan is refinanced early, how is the unamortized OID treated? What is the P&L impact at that time?"
- "Suppose the sponsor also issues $200M of bonds at par but with a 2% upfront fee paid in cash to the underwriter. How would that fee appear in the sources & uses, and how is it different from OID?"
Sources & uses
| Term Loan B | 400 |
| Senior notes | 250 |
| Sponsor equity | 370 |
| Total sources | 1,020 |
| Purchase of equity | 900 |
| Refinance existing debt | 100 |
| Financing & advisory fees | 20 |
| Total uses | 1,020 |
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