Mike Smith, CFA, an analyst with Blue River Investments, is considering buying a Montrose Cable Company corporate bond. He has collected the balance sheet and income statement information for Montrose as shown in Table 1 below. Table 1 Montrose Cable Company Year Ended March 31, 2017 (USD Thousands) Balance Sheet Current assets $4,720 Fixed assets 43,245 Total assets $47,965 Current liabilities 4,520 Long-term debt 10,000 Total liabilities $14,520 Shareholders' equity 33,445 Total liabilities and shareholders' equity $47,965 Income Statement Revenue Operating and administrative expenses Operating income Depreciation and amortization Interest expense Income before income taxes Taxes $18,500 14,100 $4,400 1,600 946 $1,854 727 Net income $1,127 He has also calculated the three ratios shown in Table 2 below, which indicate that the bond is currently rated "A" according to the firm's internal bond-rating criteria. Table 2 Selected Ratios and Credit Yield Premium Data for Montrose EBITDA/interest expense 4.65 Long-term debt/equity 0.30 Current assets/current liabilities 1.04 Credit yield premium over U.S. Treasuries 56 basis points Smith has decided to consider some off-balance-sheet items in his credit analysis, as shown in Table 3. Table 3 Montrose Off-Balance-Sheet Items Montrose has guaranteed the long-term debt (principal only) of an unconsolidated affiliate. This obligation has a present value of $990,000. Montrose has sold $515,000 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 discounted present value of the lease payments is $6,142,000 using an interest rate of 10 percent. The annual payment will be $1,000,000. Specifically, Smith wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Table 2. Assume that the "loan proceeds" from the financed receivables would be invested at interest rate of 8 percent. a. Calculate the combined effect of the three off-balance-sheet items in Table 3 on each of the following three financial ratios shown in Table 2. Do not round intermediate calculations. Round your answers to four decimal places. 1. EBITDA/interest expense: 2. Long-term debt/equity: 3. Current assets/current liabilities: b. Evaluate whether or not the credit yield premium incorporates the effect of the off-balance-sheet items, state and justify whether or not the current credit yield premium compensates Smith for the credit risk of the bond, based on the internal bond-rating criteria found in the firm's internal bond-rating criteria. Round your answers to the nearest whole number. Credit Yield Premium over U.S. Treasuries Bond Rating (in basis points) -Select- | -Select- | -Select- Interest Coverage Leverage Current Ratio the effect of the off-balance-sheet items, and the current credit yield premium of 56 basis points -Select- sufficient to compensate The current rating of the Montrose bond as an "A" -Select- Smith for the credit risk of the bond. Mike Smith, CFA, an analyst with Blue River Investments, is considering buying a Montrose Cable Company corporate bond. He has collected the balance sheet and income statement information for Montrose as shown in Table 1 below. Table 1 Montrose Cable Company Year Ended March 31, 2017 (USD Thousands) Balance Sheet Current assets $4,720 Fixed assets 43,245 Total assets $47,965 Current liabilities 4,520 Long-term debt 10,000 Total liabilities $14,520 Shareholders' equity 33,445 Total liabilities and shareholders' equity $47,965 Income Statement Revenue Operating and administrative expenses Operating income Depreciation and amortization Interest expense Income before income taxes Taxes $18,500 14,100 $4,400 1,600 946 $1,854 727 Net income $1,127 He has also calculated the three ratios shown in Table 2 below, which indicate that the bond is currently rated "A" according to the firm's internal bond-rating criteria. Table 2 Selected Ratios and Credit Yield Premium Data for Montrose EBITDA/interest expense 4.65 Long-term debt/equity 0.30 Current assets/current liabilities 1.04 Credit yield premium over U.S. Treasuries 56 basis points Smith has decided to consider some off-balance-sheet items in his credit analysis, as shown in Table 3. Table 3 Montrose Off-Balance-Sheet Items Montrose has guaranteed the long-term debt (principal only) of an unconsolidated affiliate. This obligation has a present value of $990,000. Montrose has sold $515,000 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 discounted present value of the lease payments is $6,142,000 using an interest rate of 10 percent. The annual payment will be $1,000,000. Specifically, Smith wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Table 2. Assume that the "loan proceeds" from the financed receivables would be invested at interest rate of 8 percent. a. Calculate the combined effect of the three off-balance-sheet items in Table 3 on each of the following three financial ratios shown in Table 2. Do not round intermediate calculations. Round your answers to four decimal places. 1. EBITDA/interest expense: 2. Long-term debt/equity: 3. Current assets/current liabilities: b. Evaluate whether or not the credit yield premium incorporates the effect of the off-balance-sheet items, state and justify whether or not the current credit yield premium compensates Smith for the credit risk of the bond, based on the internal bond-rating criteria found in the firm's internal bond-rating criteria. Round your answers to the nearest whole number. Credit Yield Premium over U.S. Treasuries Bond Rating (in basis points) -Select- | -Select- | -Select- Interest Coverage Leverage Current Ratio the effect of the off-balance-sheet items, and the current credit yield premium of 56 basis points -Select- sufficient to compensate The current rating of the Montrose bond as an "A" -Select- Smith for the credit risk of the bond
