B2. (Choosing financial targets) Sanderson Manufacturing Company would like to a

Question

B2. (Choosing financial targets) Sanderson Manufacturing Company would like to achieve a
capital structure consistent with a Baa2/BBB senior debt rating. Sanderson has identified
six comparable firms and calculated the credit statistics shown here.
a. Sanderson’s return on assets is 5.3%. It has a total capitalization of $600 million. What
are reasonable targets for long-term debt/cap, funds from operations/LT debt, and fixed
charge coverage?
b. Are there any firms among the six who are particularly good or bad comparables?
Explain.
c. Suppose Sanderson’s current ratio of long-term debt to total cap is 60% but its fixed
charge coverage is 3.00. What would you recommend?
FIRM A B C D E F
Senior debt rating Baa2/BBB Baa3/BBB- Baa2/BBB Baa1/A- Baa1/BBB- Baa2/BBB+
Return on assets 5.2% 5.0% 5.4% 5.7% 5.2% 5.3%
Long-term debt/cap 38% 41% 45% 40% 25% 43%
Total cap ($MM) 425 575 525 650 210 375
Funds from
operations/LT debt 39% 43% 28% 46% 57% 43%
Fixed charge cov 2.57 2.83 2.75 2.38 3.59 2.15

Explanation / Answer

Long-term debt / Capitalization target lies between 40 to 45% range . We don't use 38% because the asset size is too small for that comparision. Funds from operations/ long-term debt target lies between 30 to 40% range Fixed charges coverage target lies between 2.50 to 2.75 (Corresponds to those two firms that have Baa2/BBB ratings) Firms B and E should not be used in determining the range because their credit ratings are below the desired credit rating. Hence these are the reasonable targets for the given ratios.

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