finances [Pin It] 1- David Wright CEA. An analyst with River Investment is considering buying a Montrose Cable Company corporate bond. He has collect the following balance sheet and income statement information for Montrose as shown in Exhibit 10.10 He has also calculated the three ratios shown in EXHIBIT 10.11. Which indicate that the bond is currently rated “A” according to the firm’s internal bond rating criteria shown in Exhibit 10.13. Wright has decided to consider some off-balance –sheet items in his credit analysis, as shown in Exhibit 10.12. Specifically. Wright wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Exhibit 10.11. a. Calculate the combined effect of the three of balance sheet items in the Exhibit 10.12 on each of the following three financial ratios shown in Exhibit 10.11 1-EBITDA/interest expense. 2- Long-term debt/equity. 3-Current assets/current liabilities. The bond is currently trading at the credit premium of 25 basis points. Using the internal bond-rating criteria in Exhibit 10.13, Wright wants to evaluate whether or not the credit yield premium incorporates the effect off-balance-sheet items. b. State and justify whether or not the current credit yield premium compensates Wright for the credit risk of the bond based on the internal bond-rating criteria found in Exhibit 10.13. Exhibit 10.10 Montrose Cable Company Year Ended March 31, 2011 {Use Thousands} Balance sheet . Current assets $4,735 Fixed assets 43,225 Total assets 47,960 Current liabilities 4,500 Long-term debt 10,000 Total liabilities 14,500 Shareholder’s equity 33,460 Total liabilities and Shareholder’s equity 47,960 Income Statement . Revenue $18,500 Operating and administrative expenses $14,050 Operating income $4,450 Depreciation and amortization $1,675 Internet expense $942 Income before income taxes $1,833 Taxes $641 Net income $1,192 Exhibit 10.11 Selected Ratios and Credit Yield Premium Data for Montrose . EBITDA/interest expense 4.72 Long-term debt/equity 0.30 Current assets/ Current liabilities 1.05 Credit yield premium over U.S. Treasuries 55 basis points Exhibit 10.12 Montrose off-balance-sheet items · Montrose has guaranteed the long-term debt (principal only0 of an unconsolidated affiliate. This obligation has a present value of $995,000. · Montrose has sold $500,000 of accounts receivable with recourse at a yield of 8 percent. · Montrose is a lessee in a new noncancelable operating leasing agreement to finance transmission equipment. The discount value of the lease payments is $6,144,000 using an interest rate of 10 percent. The annual payment will be 1,000,000. Exhibit 10.13. Blue River Investments: Internal Bond-Rating Criteria Credit Yield Interest Coverage Current Ratio premium over {EBITDA/interest Leverage Long [Current assets/ U.S. Treasuries Bond Rating Expense} -term debt equity Current liabilities] in basis points AA 5.00 to 6.00 0.25 to 0.30 1.15 to 1.25 30 bps A 4.00 to 5.00 0.30 to 0.40 1.00 to 1.15 50 bps BBB 3.00 to 4.00 0.40 to 0.50 0.90 t0 1.00 100bps BB 2.00 to 3.00 0.50 to 0.60 0.75 to .090 125bvps