Mike Smith, CFA, an analyst with Blue River Investments, is considering buying a Mon- trose Cable Company Corporate bond. He has collected the balance sheet and income statement information for Montrose, as shown in Exhibit 19.24. He has also calculated the three ratios shown in Exhibit 19.25, which indicate that the bond is currently rated "A," according to the firm's internal bond-rating criteria shown in Exhibit 19.27.
Smith has decided to consider some off-balance-sheet items in his credit analysis, as shown in Exhibit 19.26. Specifically, Smith wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Exhibit 19.25.
a. Calculate the combined effect of the three off-balance-sheet items in Exhibit 19.26 on each of the following three financial ratios shown in Exhibit 19.25.
(1) EBITDA/interest expense
(2) Long-term debt/equity
(3) Current assets/current liabilities
The bond is currently trading at a credit premium of 55 basis points. Using the internal bond-rating criteria in Exhibit 19.27, Smith wants to evaluate whether or not the credit yield premium incorporates the effect of the off-balance-sheet items.
b. 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 Exhibit 19.27.
Text Book: Investment Analysis and Portfolio Management By Frank Reilly, Keith Brown.