A friend gave me this question, but we couldn't quite agree. Not looking for a quantitative answer so let's not get wild with assumptions chasing a number, but for illustration's sake, let's say we're talking about a subordinated note with a base of 10% cash interest. If given the option, would the sponsor rather it become 13% cash interest or 10% cash + 3% PIK?
A friend gave me this question, but we differed a little on the answer. Here's my thinking:
A sponsor would rather have the increase in cash interest. An increase in PIK debt does increase your cash but (1) assuming you've got a sweep on more senior debt, the cash increase from the PIK is used to pay down less expensive debt. And (2) you'll have a greater net debt balance at the exit that decreases equity.
If there's nothen you could probably invest the cash in something with a better return than the present value of the extra interest, but that's probably not realistic. Our argument essentially ended at this: the correct answer is so dependent on certain variables (sweep, other investment opportunities, timing of cash flows, etc.) that "all things equal" isn't really a fair way to give the question.