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