Friedman's Inc is a leading fine jewellery retailer.
In Nov 04, the firm said that it might default on certain of the financial covenants contained in 1 of the firm loan agreement. The following is an excerpt from the company's press release:
In particular, Friedman's expects that it will fail to meet cumulative EBITDA requirements for the period ending Oct 30 '04 constituting a default under its term loan and its revolving loan. Friedman's is currently in discussions with its senior lenders under the credit facility regarding the amendment of its covenants to eliminate the default.
Apparently, Friedman's term loan contained a provision that required the maintain a minimum level of profitability measured by EBITDA over several periods.
1. What will happen to the company if it violates these 2 covenants & is unsuccessful in obtaining a waiver or amendment from senior lenders?
2. Elaborate how the EBITDA covenant creates an incentive for Friedman's to engage in aggressive accounting practices. Provide 1 or more examples of aggressive accounting that Friedman's might use to avoid violating the EBITDA covenant.
3. Elaborate how the accounts payable to inventory covenant also creates an incentive for Friedman's to engage in aggressive accounting practices.