Q4-1. Lenders distinguish between cyclical cash needs and cash needed to fund operating losses because the second type of cash is riskier. It is typical for firms such as retailers to experience cyclical cash flows during the year as they gear up for busy season (October – December for many retailers). This happens in the ordinary course of business. In contrast, operating losses are not routine and can signal ongoing liquidity problems, or at worst, bankruptcy.
Q4-10. Two factors impact credit risk: potential for default, and the magnitude of loss given a default.
Chance of default can be measured via credit analysis, which attempts to capture the probability ...view middle of the document...
However, the company must make significant capital investments and has a large asset base. This yields CAPEX ratio and EBITA to total assets at the lower end of investment-grade debt.
Pfizer, Inc., (PFE) demonstrates marked improvement in almost all aspects of financial health, making the company less risky to creditors in 2006. Its 2006 liquidity ratios (both current and quick) are higher than the prior year.
In terms of solvency, leverage decreased in 2006, as the company seems to be drawing upon equity financing more than debt financing according to its liabilities-to-equity and long-term debt-to-equity ratios.
Finally, although its factor of times interest earned decreased marginally, it is still clearly covering all interest expenses associated with debt obligations (nearly 30 times over), and its cash from operations to total debt and free operating cash flow to total debt increased markedly from 2005 to 2006.
Z-score = 1.2 × (WC/TA) + 1.4 × (RE/TA) + 3.3 × (EBIT/TA) + 0.6 × (MVE/TL) + 0.99 (Sales/TA)
(1.2 × 0.042) + (1.4 × 0.033) +(3.3 × 0.05) +(0.6 × 0.39) +(0.99 × 0.573) = 1.06
(1.2 × 0.058) + (1.4 × 0.019) +(3.3 × 0.04) +(0.6 × 0.32) +(0.99 ×0.503) = 0.92
According to the Z-scores for JetBlue, the company is in financial distress and there is high bankruptcy potential. Although the Z-score has improved slightly in 2010, the scores are substantially less than 1.8 for both years.
a. Following are Home Depot’s financial ratios along with each ratio’s implied bond rating using the table results from Exhibit 4.6.
Ratio 2011 Implied rating
EBITA / average assets $5,839 / [($40,877 + $40,125) / 2]
= 14.42% Aaa to Aa
Operating income margin $5,273 / $ 67,997
= 7.75% B
EBITA margin $5,839 / $67,997
= 8.59% B
EBITA interest coverage $5,839 / $530
= 11.02 Aa
Debt / EBITDA ($1,042 + $8,707) / ($5,839 + $1,616)
= 1.31 Aaa to Aa
Debt / book capitalization ($1,042 + $8,707) / ($1,042 + $8,707 + $18,889 + $272)
= 33.72% Aaa to Aa
Retained cash flow to debt ($4,585 - $1,569) / ($1,042 + $8,707)
= 30.94% A
b. From an assessment of the profitability ratios above, Home Depot’s credit rating would be somewhere around a B. However, the coverage and solvency ratios are much stronger and place the company between A and Aa (some near the Aaa range). All aspects continued, the company is in the Aa range. As described in the module, Moody’s rated Home Depot long-term debt at A3, which is between A and Aa, as of late 2011.
($ millions) Times interest earned
2010 $(5,629 + 536) / $536 = 11.50
2009 $(5,913 + 525) / $525 = 12.26
2008 $(5,537 + 509) / $509 = 11.88
The times interest earned ratio rose slightly in 2009 and then fell in 2010. However, the ratio is very high and CVS is able to cover its interest expense by a comfortable margin.
($ millions) Current Ratio
2010 $17,706 / $11,070 = 1.60...