Food Galore operates a chain of retail supermarkets. The supermarket business is highly competitive, and it is characterized by low profit margins. Food Galore recently entered into a credit agreement with a group of banks. Excerpts from the loan agreement follow. Fixed Charges Coverage The ratio of Income Available for Fixed Charges to Fixed Charges shall be at least 1.50 at every quarter end.

Limitation on Additional Debt The Borrower will not create, assume or incur any additional debt unless the ratio of Income Available for Fixed Charges to Fixed Charges for each of the previous eight fiscal quarter ends has been at least 2.00.

Minimum Tangible Net Worth Tangible Net Worth shall at no time be less than (i) $500 million plus (ii) 25% of the cumulative Net Income of the Borrower since the signing of the agreement minus (iii) 25% of the cumulative dividends declared by the Borrower since the signing of the agreement.

Required:

1. In two more weeks, the company’s books will be closed for the quarter, and the fixed charges coverage might fall below the level required by the loan agreement. How can management avoid violating this covenant?

2. The company’s tangible net worth may also fall below the amount specified in the loan agreement. How can management avoid violating this covenant?

3. Elsewhere in the loan agreement it says that the company’s ratio of consolidated debt to total capitalization must be no more than 0.75 to 1.0. How can management avoid violating this covenant?

4. Suppose you are one of Food Galore’s bankers and you are considering making changes to the loan covenants. What management activities would you most want to limit? Why?