David Wright, CFA, an analyst with Blue River Investments, is considering buying a Montrose Cable Company corporate bond. He has collected the following balance sheet and income statement information for Montrose as shown in Exhibit. He has also calculated the three ratios shown in Exhibit, which indicate that the bond is currently rated "A" according to the firm's internal bond-rating criteria shown in Exhibit.

Wright has decided to consider some off-balance-sheet items in his credit analysis, as shown in Exhibit. Specifically, Wright wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Exhibit.

a. Calculate the combined effect of the three off-balance-sheet items in Exhibit on each of the following three financial ratios shown in Exhibit.

In Exhibit Montrose Cable Company Year Ended March 31, 2011

(US$ Thousands)

Balance Sheet

Current assets ................. $ 4,735

Fixed assets ................... 43,225

Total assets ...................$47,960

Current liabilities ................$ 4,500

Long-term debt ................ 10,000

Total liabilities ................$14,500

Shareholders’ equity ................ 33,460

Total liabilities and shareholder’s equity ......$47,960

Income Statement

Revenue ...................$18,500

Operating and administrative expenses ........ 14,050

Operating income ...............$ 4,450

Depreciation and amortization .......... 1,675

Interest expense ................ 942

Income before income taxes ............$ 1,833

Taxes ..................... 641

Net income .................$ 1,192

In Exhibit Selected Ratios and Credit Yield Premium Data for Montrose

EBITDA/interest expense ...........4.72

Long-term debt/equity ...........0.30

Current assets/current liabilities .........1.05

Credit yield premium over U.S. Treasuries .... 55 basis points

In Exhibit 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 $995,000.

Montrose has sold $500,000 of accounts receivable with recourse at a yield of 8 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 $6,144,000 using an interest rate of 10 percent. The annual payment will be $1,000,000.

i. EBITDA/interest expense

ii. Long-term debt/equity

iii. 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, Wright 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 Wright for the credit risk of the bond based on the internal bond-rating criteria found in Exhibit.