Vol. 3 LM4 Credit Analysis & Geographic Segments Flashcards
Concept
is the risk of loss caused by a counterparty’s or debtor’s failure to make a promised payment
p. 235
credit risk
Concept
is the evaluation of credit risk
p. 235
credit analysis
Concept
a statistical analysis of the determinants of credit default
p. 235
credit scoring
Concept
can be either long-term or short-term and is an indication of the rating angency’s opinion of the creditworthiness of a debt issuer with respect to a specific debt security
credit rating
Concept
involves both the analysis of a company’s financial reports as well as a broad assessment of a company’s operations
p. 236
credit rating process
Describe
(industry level) qualitative factors of a corporate credit rating
p. 236
industry level
* growth prospects
* volatility
* technological change
* competitive environment
Describe
(company level) qualitative factors of a corporate credit rating
p. 236
company level
* operational effectiveness,
* strategy
* governance
* financial policies
* risk management practices
* risk tolerance
Describe
quantitative factors of a corporate credit rating
p. 236
generally include:
* profitability
* leverage
* cash flow adequacy
* liquidity
Calculate
EBITDA interest coverage
p. 236
numerator EBITDAb
denominator interest expense, including non-cash interest on conventional debt instruments
b EBITDA = EBIT, depreciation, and amortization
Calculate
FFOc (funds from operations) to debt
p. 236
numerator FFO
denominator total debt
c EBITDA - net interest expense - tax expense
Calculate
Free operating cash flow to debt
p. 236
numerator CFOd (adjusted) minus capital expenditures
denominator total debt
d CFO = cash flow from operations
Calculate
EBIT margin
p. 236
numerator EBIT
denominator total revenues
Calculate
EBITDA margin
p. 236
numerator EBITDA
denominator total revenues
Calculate
debt to EBITDA
p. 237
numerator total debt
denominator EBITDA
p. 237
Calculate
return on capital
p. 237
numerator EBIT
denominator Average beginning-of-year and end-of-year capital
Calculate
Altman’s Z-score to predict financial distress
p. 237
Z = 1.2 x (Current assets - current liabilities)/Total assets +
* 1.4 x (Retained earnings/Total assets)
* + 3.3 x (EBIT/Total assets)
* + 0.6 x (Market value of stock/Book value of liabilities)
* + 1.0 x (Sales/Total assets)
Define
operating segment
p. 238
- that engages in activities that may generate revenue and create expenses, including a start up segment that has yet to earn revenues
- who results are regularly reviewed by senior management
- for which discrete financial information is avialable
List
a company must disclose separate information about any operation segment under which conditions
p. 238
- the segment constitutes 10 percent or more of the combined operation segments’ revenue, assets, or profit
- the criteria is expressed in terms of the absolute value of the segment’s profit or loss as a percentage of the greater
a. the combined profits of all profitable segments and
b. the absolute amount of the combined losses of all loss-making segments
List disclosures
each reportable segment
p. 238
- a measure of profit or loss;
- a measure of total assets and liabilities
- segment revenue, distinguishing between revenue to external customers and revenue from other segments
- interest revenue and interest expense;
- cost of property, plant, and equipment, and intangible assets acquired;
- depreciation and amortisation expense;
- other non-cash expenses;
- income tax expense or income; and
- share of the net profit or loss of an investment accounted for under the equity method
List
segment ratios
p. 239
- segment margin
- segment turnover
- segment ROA
- segment debt ratio
Concept
also known as “what if” analysis, which shows the range of possible outcomes as specific assumptions are changed; this could, in turn, influence financing needs or investment in fixed assets
p. 242
sensitivity analysis
Concept
This type of analysis shows the changes in key financial quantities that result from given (economic) events, such as the loss of customers, the loss of a supply source, or a catastrophic event
p. 242
scenario analysis
Concept
This is computer-generated sensitivity or scenario analysis based on probability models for the factors that drive outcomes
p. 242
simulation
P1
Comparison of a company’s financial results to other peer companies for the same time period is called:
A. technical analysis.
B. time-series analysis.
C. cross-sectional analysis.
Practice Problems
p. 245
C. cross-sectional analysis
P2
An analyst observes a decrease in a company’s inventory turnover. Which of the following would most likely explain this trend?
A. The company installed a new inventory management system, allowing more efficient inventory management.
B. Due to problems with obsolescent inventory last year, the company wrote off a large amount of its inventory at the beginning of the period.
C. The company installed a new inventory management system but experienced some operational difficulties resulting in duplicate orders being placed with suppliers.
Practice Problems
p. 245
C.
The company’s problems with its inventory management system
causing duplicate orders would likely result in a higher amount of inventory and would, therefore, result in a decrease in inventory turnover.
A more efficient inventory management system and a write off of inventory at the beginning of the period would both likely decrease the average inventory for the period (the
denominator of the inventory turnover ratio), thus increasing the ratio rather than decreasing it.
P3
Which of the following would best explain an increase in receivables turnover?
A. The company adopted new credit policies last year and began offering credit to customers with weak credit histories.
B. Due to problems with an error in its old credit scoring system, the company had accumulated a substantial amount of uncollectible accounts and wrote off a large amount of its receivables.
C. To match the terms offered by its closest competitor, the company adopted new payment terms now requiring net payment within 30 days rather than 15 days, which had been its previous requirement.
Practice Problems
p. 245
B.
A write off of receivables would decrease the average amount of
accounts receivable (the denominator of the receivables turnover ratio), thus increasing this ratio. Customers with weaker credit are more likely to make payments more slowly or to pose collection difficulties, which would likely increase the average amount of accounts receivable and thus decrease receivables turnover. Longer payment terms would likely increase the average amount of accounts receivable and thus decrease receivables turnover.
P4
Brown Corporation had average days of sales outstanding of 19 days in the most recent fiscal year. Brown wants to improve its credit policies and collection practices and decrease its collection period in the next fiscal year to match the
industry average of 15 days. Credit sales in the most recent fiscal year were $300 million, and Brown expects credit sales to increase to $390 million in the next fiscal year. To achieve Brown’s goal of decreasing the collection period, the change
in the average accounts receivable balance that must occur is closest to:
A. +$0.41 million.
B. –$0.41 million.
C. –$1.22 million.
Practice Problems
p. 245
A.
Turnover equals 365 divided by DSO.
Turnover is 19.21 (= 365/19) for the most recent fiscal year and is targeted to be 24.33 (= 365/15) for the next fiscal year. The average accounts receivable balances are $15.62 million (= $300,000,000/19.21), and $16.03 million (=
$390,000,000/24.33). The change is an increase in receivables of $0.41 million
P6
In order to assess a company’s ability to fulfill its long-term obligations, an analyst would most likely examine:
A. activity ratios.
B. liquidity ratios.
C. solvency ratios.
Practice Problem
p. 245
C.
P10
Which ratio would a company most likely use to measure its ability to meet short-term obligations?
A. Current ratio.
B. Payables turnover.
C. Gross profit margin.
Practice Problems
p. 247
A.
P11
Which of the following ratios would be most useful in determining a company’s ability to cover its lease and interest payments?
A. ROA.
B. Total asset turnover.
C. Fixed charge coverage.
Practice Problems
p. 247
C.
The fixed charge coverage ratio is a coverage ratio that relates known fixed charges or obligations to a measure of operating profit or cash flow generated by the company. Coverage ratios, a category of solvency ratios, measure the ability of a company to cover its payments related to debt and leases.
Assuming no changes in other variables, which of the following would decrease ROA?
A. A decrease in the effective tax rate.
B. A decrease in interest expense.
C. An increase in average assets.
Practice Problems
p. 247
C.
Assuming no changes in other variables, an increase in average assets (an increase in the denominator) would decrease ROA. A decrease in either the effective tax rate or interest expense, assuming no changes in other variables, would increase ROA.
P20
What does the P/E ratio measure?
A. The “multiple” that the stock market places on a company’s EPS.
B. The relationship between dividends and market prices.
C. The earnings for one common share of stock.
Practice Problems
p. 250
A.
The P/E ratio measures the “multiple” that the stock market places on a company’s EPS.
P21
A creditor most likely would consider a decrease in which of the following ratios to be positive news?
A. Interest coverage (times interest earned).
B. Debt-to-total assets.
C. Return on assets.
Practice Problems
p. 251
B.
In general, a creditor would consider a decrease in debt to total
assets as positive news. A higher level of debt in a company’s capital structure increases the risk of default and will, in general, result in higher borrowing costs for the company to compensate lenders for assuming greater credit risk. A decrease in either interest coverage or return on assets is likely to be considered negative news.