Problem 13-12

Mike Smith, CFA, an analyst with Blue River Investments, is considering buying a Montrose Cable Company corporate bond. He has collected the balance sheet and income statement information for Montrose as shown in Table 1 below.

Table 1 Montrose Cable Company Year Ended March 31, 2017 (USD Thousands)
Balance Sheet
Current assets	$4,705
Fixed assets	43,270
Total assets	$47,975
Current liabilities	4,530
Long-term debt	10,000
Total liabilities	$14,530
Shareholders' equity	33,445
Total liabilities and shareholders' equity	$47,975
Income Statement
Revenue	$18,500
Operating and administrative expenses	14,070
Operating income	$4,430
Depreciation and amortization	1,655
Interest expense	939
Income before income taxes	$1,836
Taxes	694
Net income	$1,142

He has also calculated the three ratios shown in Table 2 below, which indicate that the bond is currently rated "A" according to the firm's internal bond-rating criteria.

Table 2 Selected Ratios and Credit Yield Premium Data for Montrose
EBITDA/interest expense	4.72
Long-term debt/equity	0.30
Current assets/current liabilities	1.04
Credit yield premium over U.S. Treasuries	60	basis points

Smith has decided to consider some off-balance-sheet items in his credit analysis, as shown in Table 3.

Table 3 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 $990,000.
• Montrose has sold $525,000 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 $6,138,000 using an interest rate of 10 percent. The annual payment will be $1,000,000.

Specifically, Smith wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Table 2. Assume that the "loan proceeds" from the financed receivables would be invested at interest rate of 8 percent.

1. Calculate the combined effect of the three off-balance-sheet items in Table 3 on each of the following three financial ratios shown in Table 2. Do not round intermediate calculations. Round your answers to four decimal places.

   1. EBITDA/interest expense: **NEED ANSWER**
   2. Long-term debt/equity: **NEED ANSWER**
   3. Current assets/current liabilities: **NEED ANSWER**

2. Evaluate whether or not the credit yield premium incorporates the effect of the off-balance-sheet items, 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 the firm's internal bond-rating criteria. Round your answers to the nearest whole number.

   		Credit Yield Premium
   		over U.S. Treasuries
   	Bond Rating	(in basis points)
   Interest Coverage	(FILL IN BLANK OPTIONS: AA, A, BBB, BB,)	**NEED ANSWER**
   Leverage	(FILL IN BLANK OPTIONS: AA, A, BBB, BB,)	**NEED ANSWER**
   Current Ratio	(FILL IN BLANK OPTIONS: AA, A, BBB, BB,)	**NEED ANSWER**

   The current rating of the Montrose bond as an "A" (FILL IN BLANK OPTIONS: DOES NOT INCORPORATE, OR INCORPORATE) the effect of the off-balance-sheet items, and the current credit yield premium of 60 basis points (FILL IN BLANK OPTIONS: IS, OR IS NOT) sufficient to compensate Smith for the credit risk of the bond.