Question

As a new employee of Clayton Asset Management, you are assigned to evaluate the credit quality of BRT Corp. bonds. Clayton holds the bonds in its high-yield bond portfolio. The following information is provided to assist in the analysis.
1. BRT Corporation is a rapidly growing company in the broadcast industry. It has grown primarily through a series of aggressive acquisitions.
2. Early in Year 6, BRT announced it was acquiring a competitor in a hostile takeover that would double its assets but also increase debt. The credit rating of BRT debt fell from BBB to BB. The acquisition reduced the financial flexibility of BRT but increased its presence in the broadcasting industry.
3. In the middle of Year 7, BRT announced it is merging with another large entertainment company. The merger will alter BRT's capital structure and also make it the leader in the broadcast industry. The Year 6 acquisition combined with this merger will increase the total assets of BRT by a factor of four. A large portion of the total assets are intangible, representing franchise and distribution rights.
4. While the outlook for the broadcasting industry remains strong, large telecommunication companies attempting to enter the broadcasting industry are keeping competitive pressures high. Laws and regulations also promote the competitiveness of the environment, but initial start-up costs make it difficult for new companies to enter the industry. Large capital expenditures are required to maintain and improve existing systems as well as to expand current business.
5. For your analysis, you are provided with the financial data shown here:

BRT CORPORATION
Balance Sheet Data (in millions)
At December 31


CLAYTON ASSET MANAGEMENT
Credit Rating Standards


Required:
a. Calculate the following ratios using the projected Year 7 financial information:
(1) Operating income to sales.
(3) Times interest earned.
(2) Earnings before interest and taxes to total assets.
(4) Long-term debt to total assets.
b. Discuss the effect of the Year 7 merger on the creditworthiness of BRT through an analysis of each of the ratios in (a).
c. BRT Corporation 10-year bonds are currently rated BB and are trading at a yield to maturity of 7.70%. The current 10-year Treasury note is yielding 6.15%. Based on your work in (a) and (b), the background information, and information on Selected Ratios and Credit Rating Standards, state and justify whether Clayton should hold or sell the BRT Corporation bonds in its portfolio. Include qualitative factors in your discussion.
(CFAadapted)


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  • CreatedJanuary 22, 2015
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