Chapter 10: Problem 5(a-b) 5. David Wright, CFA, an analyst

  

Chapter 10: Problem 5(a-b)5.David Wright, CFA, an analyst with Blue River Investments, isconsidering buying a Montrose Cable Company corporate bond. He hascollected the following balance sheet and income statement informationfor Montrose as shown in Exhibit 10.10. He has also calculated the threeratios shown in Exhibit 10.11, which indicate that the bond is currentlyrated A according to the firms internal bond-rating criteria shown inExhibit 10.13. Wright has decided to consider some off-balance-sheetitems in his credit analysis, as shown in Exhibit 10.12. Specifically,Wright wishes to evaluate the impact of each of the off-balance-sheetitems on each of the ratios found in Exhibit 10.11.a. Calculate the combined effect of the three off-balance-sheet items inExhibit 10.12 on each of the following three financial ratios shown in Exhibit10.11.i. EBITDA/interest expenseii. Long-term debt/equityiii. Current assets/current liabilitiesThe bond is currently trading at a credit premium of 55 basis points. Using theinternal bond-rating criteria in Exhibit 10.13, Wright wants to evaluatewhether or not the credit yield premium incorporates the effect of the offbalance-sheet items.b. State and justify whether or not the current credit yield premiumcompensates Wright for the credit risk of the bond based on the internalbond-rating criteria found in Exhibit 10.13. Chapter 10: Problem 5(a-b)Exhibit 10.10 Montrose Cable CompanyYear Ended March 31, 201 (US$Thousands)Balance SheetCurrent Assets$ 4,735Fixed Assets$ 43,225Total assets$ 47,960Current Liabilities$ 4,500Long-term debt$ 10,000Total Liabilities$ 14,500Shareholders’ Equity$ 33,460Total Liabilities and Shareholders’ Equity $ 47,960Income StatementRevenueOperating and Administrative ExpensesOperating incomeDepreciation and AmortizationInterest ExpenseIncome before interest and taxesTaxesNet Income$ 18,500$ 14,050$ 4,450$ 1,675$942$ 1,833$641$ 1,192Exhibit 10.11 Selected Ratios and CreditYield Premium Data for MontroseEBITDA/Interest ExpenseLong-term debt/equityCurrent assets/current liabilitiesCredit yield premium over U.S. Treasuries4.720.301.0555 basis pointsExhibit 10.12 Montrose Off-Balance-SheetItemsMontrose has guaranteed the long-term debt (principal only) of anunconsolidated affilate. This obligation has a present value of $995.00.Montrose has sold $500,000 of accounts receivable with recourse at a yieldof 8 percent.Montrose is a lessee in a new noncancelable operating leasing agreement tofinance transmission equipment. The discounted present value of the leasepayments is $6,144,000 using an interest rate of 10 percent. The annualpayment will be $1,000,000.Exhibit 10.13 Blue River Investment:Internal Bond-Rating Criteria and CreditYield Premium Data

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