Question

You are a pension fund manager looking for an investment that will provide a reliable stream of income over the next 5 years. You want to find the best yield possible while still conforming to the pension fund covenant of investing in investment grade bonds or better. Decide among the following investment options for your fund.

a. Eastern Telecommunications Inc.: 5 years, 10% yield, EBIT Interest Coverage ratio = 4.4, EBITDA interest coverage ratio = 5.8, total debt of $72,625,000 (all of which is long term), total equity of $175,000,000, and a return on equity (ROE) of 7.9%.

b. Anderson Nuclear Power: 5 years, 15% yield, EBIT Interest Coverage ratio = 0.75, EBITDA interest coverage ratio = 0.9, total debt of $48,000,000, total equity of $70,000,000, and a return on capital (ROE) of 7.8%.

c. Titan Tech Company: 5 years, 6% yield, EBIT Interest Coverage ratio = 24.1, EBITDA interest coverage ratio = 30.5, total debt of $90,000,000 (all of which is long term), total equity of $1,500,000,000, and a return on equity (ROE) of 19.9%.

The following table shows the three-year median ratios for U.S. Industrials with long-term debt. Use the table to discuss the pros and cons of each investment option, described above. Determine the grade of each bond (as closely as you can). Which bond is appropriate for your pension fund?

	AAA	AA	A	BBB	BB	B	CCC
EBIT Interest Coverage	21.4	10.1	6.1	3.7	2.1	0.8	0.1
EBITDA Interest Coverage	26.5	12.9	9.1	5.8	3.4	1.8	1.3
Return on equity (%)	34.9	34.9	19.4	13.6	11.6	6.6	1.0
Long-term debt/equity (%)	13.3	13.3	33.9	42.5	57.2	69.7	68.8
Total debt/equity (%)	22.9	22.9	42.5	48.2	62.6	74.8	87.7

Answer:

a. Eastern Telecommunications Inc.:

b. Anderson Nuclear Power:

c. Titan Tech Company

d. Summary recommendation:

Answer 1

For Eastern Telecom, EBIT interest coverage ratio is 4.4 which is comparable to BBB or above. EBITDA is 5.8 suggest same BBB rating, ROE is 7.9% which is lesser than BB rated firm, long term debt to equity is 41.5% which is comparable to BBB rated firm. Hence Eastern telecom suggestive rating is BBB or less.

For Anderson, EBIT interest coverage ratio is 0.75 which is comparable to B or less. EBITDA is 0.9 suggest same CCC or lower rating, ROE is 7.8% which is lesser than BB rated firm, long term debt to equity is 68.57% which is comparable to CCC rated firm. Hence Anderson nuclear power suggestive rating is CCC or less.

The correct answer is C -> Titan Tech Company

Reasons:

Pension fund is looking for reliable stream of income and will conform to standards along with investing in investment grade bonds. Here investment grade bonds refer to rating with BBB or more.

a. EBIT interest coverage ratio is 24.1 which is higher than AAA rated company, which suggests strong payment capacity through operations

b. EBITDA is 30.5 which is again higher compared to AAA rated company

c. Long Term Debt is 90 million and equity is 1500 million which forms debt to equity ratio of 6% which is very healthy and suggests the strength of company

Hence recommendation is Titan Tech Company.