Problem 13-12 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 | $4,735 | | Fixed assets | 43,275 | | Total assets | $48,010 | | Current liabilities | 4,550 | | Long-term debt | 10,000 | | Total liabilities | $14,550 | | Shareholders' equity | 33,460 | | Total liabilities and shareholders' equity | $48,010 | | | Income Statement | | Revenue | $18,540 | | Operating and administrative expenses | 14,060 | | Operating income | $4,480 | | Depreciation and amortization | 1,660 | | Interest expense | 940 | | Income before income taxes | $1,880 | | Taxes | 767 | | Net income | $1,113 | | 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 | 4.77 | | Long-term debt/equity | 0.30 | | Current assets/current liabilities | 1.04 | | Credit yield premium over U.S. Treasuries | 52 | 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 $985,000.
- Montrose has sold $515,000 of accounts receivable with recourse at a yield of 10 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 $6,146,000 using an interest rate of 12 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 10 percent. -
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. - EBITDA/interest expense:
- Long-term debt/equity:
- Current assets/current liabilities:
-
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) | Interest Coverage | -Select-AAABBBBBItem 4 | | Leverage | -Select-AAABBBBBItem 6 | | Current Ratio | -Select-AAABBBBBItem 8 | | The current rating of the Montrose bond as an "A" -Select-does not incorporateincorporateItem 10 the effect of the off-balance-sheet items, and the current credit yield premium of 52 basis points -Select-isis notItem 11 sufficient to compensate Smith for the credit risk of the bond. |