The Phelps Corporation has $8 million of 10 percent mortgage bonds outstanding under an open-end indenture. The indenture allows additional bonds to be issued as long as all of the following conditions are met:

a. Pretax interest coverage [(income before taxes + bond interest)/bond interest] remains greater than 4.

b. Net depreciated value of mortgage assets remains twice the amount of mortgage debt.

c. Debt-to-equity ratio remains below 0.5. The Phelps Corporation has net income after taxes of $2 million and a 40 percent tax rate, $40 million in equity, and $30 million in depreciated assets, covered by the mortgage. Assuming that 50 percent of the proceeds of a new issue would be added to the base of mortgaged assets and that the company has no sinking-fund payments until next year, how much more 10 percent debt could be sold under each of the three conditions? Which protective covenant is binding?

Answer rating: 100% (QA)

ANSWER a Pretax interest coverage income before taxes bond interestbond interest remains greater tha... View the full answer