Question :

1. Why would a company pay to have its public debt rated by a major rating agency (such as Moody's or Standard and Poor's)? Why might a firm choose not to have its debt rated?

2. Wollongong Construction Company follows the percentage-of-completion technique for reporting long-term contract revenues. The percentage of completion is based on the cost of materials shipped to the project site as a percentage of net expected material costs (i.e. expenses are recorded during the life of the project and not at the end of the project). Wollongong's major debt agreement includes restrictions on net worth, minimum working capital and interest coverage needs. A leading analyst claims that 'the company is buying its way out of these covenants by spending cash and buying materials, even when they are not needed'.

(a) Describe how this might be possible.

(b) Consider the analyst is correct; will this behavior have any impact on the company's Z-score? Describe.

3. A leading retailer finds itself in a financial bind. It doesn't have sufficient cash flow from operations to finance its growth, and it is close to violating the maximum debt-to-assets ratio allowed by its covenants. The marketing director suggests: "We can raise cash for our expansion by selling the existing stores and leasing them back. This source of financing is cheap, since it avoids violating either the debt-to-assets or interest coverage ratios in our covenants." Do you agree with his analysis? Why or why not? As the firm's banker, how could you view this arrangement?