Question

Compute and Interpret Liquidity, Solvency and Coverage Ratios
Selected balance sheet and income statement information for Calpine Corporation for 2004 and 2006 follows.

($ millions)	2004	2006
Cash	$ 1,376.73	$ 1,503.36
Accounts receivable	1,097.16	735.30
Current assets	3,563.56	3,168.33
Current liabilities	3,285.39	6,057.95
Long-term debt	16,940.81	3,351.63
Short-term debt	1,033.96	4,568.83
Total liabilities	22,628.42	25,743.17
Interest expense	1,516.90	1,288.29
Capital expenditures	1,545.48	211.50
Equity	4,587.67	(7,152.90)
Cash from operations	9.89	155.98
Earnings before interest and taxes	1,589.84	1,877.84

(a) Compute the following liquidity, solvency and coverage ratios for both years. (Round your answers to two decimal places.)
2006 current ratio = Answer
2004 current ratio = Answer

2006 quick ratio = Answer
2004 quick ratio = Answer

2006 liabilities-to-equity = Answer
2004 liabilities-to-equity = Answer

2006 total debt-to-equity = Answer
2004 total debt-to-equity = Answer

2006 times interest earned = Answer
2004 times interest earned = Answer

2006 cash from operations to total debt = Answer
2004 cash from operations to total debt = Answer

2006 free operating cash flow to total debt = Answer
2004 free operating cash flow to total debt = Answer

(b) Which of the following best describes the company's credit risk?

Both the quick ratio and current ratio for 2006 are lower than 1.0 and have increased in the past two years. Along with interest coverage ratios that are exceedingly high, the probability that the company will face default has significantly increased.

Both the quick ratio and current ratio for 2006 are lower than 1.0 and have decreased in the past two years. Along with interest coverage ratios that are exceedingly low, the probability that the company will face default has significantly increased.

Both the quick ratio and current ratio for 2006 are above 1.0 and have decreased in the past two years. Along with interest coverage ratios that are exceedingly low, the probability that the company will face default has significantly decreased.

Both the quick ratio and current ratio for 2006 are above 1.0 and have increased in the past two years. Along with interest coverage ratios that are exceedingly high, the probability that the company will face default has significantly decreased.

Answer 1

All amounts are in millions of $

(a)

Current Ratio = Current Assets / Current Liabilities

For 2004 = (1376.73 + 1097.16 + 3563.56) / 3285.39 = 1.84

For 2006 = (1503.36 + 735.30 + 3168.33) / 6057.95 = 0.89

Quick Ratio = Quick Assets / Current Liabilities = (Cash + Accounts Receivable) / Current Liabilities

For 2004 = (1376.73 + 1097.16 ) / 3285.39 = 0.75

For 2006 = (1503.36 + 735.30) / 6057.95 = 0.37

Liabilities to equity = Total Liabilities / Equity

For 2004 = 22628.42 / 4587.67 = 4.93

For 2006 = 25743.17 / (-7152.9) = -3.60

Total Debt to Equity = Debt / Equity

(Generally, even in debt equity ratio we have to consider total liabilities as Debt. But as the question asked two different ratios, we have considered only Short term and Long term debt for this ratio and left out current liabilities)

For 2004 = (16940.8 + 1033.96) / 4587.67 = 3.92

For 2006 = (13351.63 + 4568.83) / (-7152.9) = -2.51

Times Interest Earned (TIE) = EBIT / Interest

For 2004 = 1589.84 / 1516.9 = 1.05

For 2006 = 1877.84 / 1288.29 = 1.46

Cash from Operations to Total Debt = Cash from Operations / Total debt

(Total liabilities are considered as Total debt, alternatively only long term debt may be considered. But that may lead to wrong potrayal of ratios as the short term debt and current liabilities has increased significantly during 2006)

For 2004 = 9.89/22628.42 = 0.04% or 0.0004

For 2006 = 155.98/25743.17 = 0.61% or 0.0061

Free Operating Cash flow to Total Debt = Free Cash flows / Total debt

(Free Cash flows are derived by reducing the capital expenditure from the Cash from operations)

For 2004 = (9.89 - 1545.48) / 22628.42 = -0.0679 or -6.79%

For 2006 = (155.98 - 211.5) / 25743.17 = -0.0022 or -0.22%

(b) 2nd Statement is True

Both the quick ratio and current ratio for 2006 are lower than 1.0 and have decreased in the past two years. Along with interest coverage ratios that are exceedingly low, the probability that the company will face default has significantly increased