Question

Problem 6-10 Making credit-rating changes (LO6-7)

Exhibit 6.5 describes the key financial ratios Standard & Poor’s analysts use to assess credit risk and assign credit ratings to industrial companies. Those same financial ratios for a single company over time follow. The company was assigned a AAA credit rating at the beginning of 2013.

	2016				2017
	Q1	Q2	Q3	Q4	Q1	Q2
EBIT interest coverage	23.8	22.1	21.6	20.8	20.6	12.4
EBITDA interest coverage	25.3	26.4	25.6	23.2	22.9	16.5
FFO/Total debt (%)	167.8	150.8	130.7	128.4	80.2	76.2
Free operating cash flow/Total debt (%)	104.1	107.3	103.7	98.6	61.5	45.3
Total debt/EBITDA	0.2	0.2	0.2	0.6	0.8	1.0
Return on capital (%)	35.1	34.3	30.6	28.1	25.9	24.7
Total debt/Capital (%)	6.2	6.8	7.5	15.4	27.2	35.6

Required:

Did the company’s credit risk increase or decrease over these six quarters?

What credit rating should be assigned to the company as of Q2 in 2017?

Which is the quarter from the table above that Standard & Poor's would first consider downgrading this company's credit rating?

1.	Did the company’s credit risk increase or decrease over these six quarters?
2.	What credit rating should be assigned to the company as of Q2 in 2017?
3.	Which is the quarter from the table above that Standard & Poor's would first consider downgrading this company's credit rating?

Answer 1

Did the company’s credit risk increase or decrease over these six quarters?

All the credit parameters have worsened over period of time. Hence, the credit risk has increased.

What credit rating should be assigned to the company as of Q2 in 2017?

Based on the exhibit 6.5, the company should now be assigned a credit rating of AA.

Which is the quarter from the table above that Standard & Poor's would first consider downgrading this company's credit rating?

Until Q1 of 2017, the parameters are better than that required for AA rating. In Q2 of 2017, the parameters have worsened further and thus moved into the threshold of AA rating. Hence, Q1 of 2017 is the quarter from the table above that Standard & Poor's would first consider downgrading this company's credit rating.

answered by: anonymous