Compute and Interpret Liquidity, Solvency and Coverage Ratios Selected balance s
ID: 2772889 • Letter: C
Question
Compute and Interpret Liquidity, Solvency and Coverage Ratios
Selected balance sheet and income statement information for Calpine Corporation for 2004 and 2006 follows.
(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 long-term debt-to-equity = Answer
2004 long-term 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 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 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 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.
($ millions) 2004 2006 Cash $ 1,256.73 $ 1,523.36 Accounts receivable 1,097.16 735.30 Current assets 3,313.56 3,268.33 Current liabilities 3,285.39 6,057.95 Long-term debt 17,150.81 3,531.63 Short-term debt 1,033.96 4,568.83 Total liabilities 22,898.42 25,503.17 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 19.89 335.98 Earnings before interest and taxes 1,659.84 1,907.84Explanation / Answer
a. Current Ratio = Current Assets/Current Liabilities
2004 Current Ratio = 3313.56/3285.39
= 1.008
2006 Current Ratio = 3268.33/6057.95
= 0.539
Since Current ratio has decreased Company will not be able to meet its current obligation through current assets.
Quick Ratio = Quick Assets/ Current Liabilities
2004 Quick Ratio = (Cash + Receivables)/Current Liabilities
= (1256.73+1097.16+19.89)/3285.39
= 0.722
2006 Quick Ratio = (1523.36+735.30+335.98)/6057.95
= 0.428
Since the Quick Ratio has decreased Company will not be able to meet its current obligation through current assets. Further, Current Assets that are more difficult to encash are removed from the current assets and the quick ratio is significantly below 1 the company will face serious liquidity issues.
Liabilities to Equtiy Ratio = Total Liabilities/ Equity
2004 Liabilities to Equity ratio= 22898.42/4587.67
= 4.99:1
2006 Liabilities to Equity ratio = 25503.17/-7152.90
= -3.565:1
The equity has gone negative in 2006 which means there has been huge losses. Hence the company is facing solvency issues.
Long Term Debt to Equity Ratio = Long Term Debt/ Equity
2004 Long Term Debt to Equity Ratio = 17150.81/4587.67
= 3.74:1
2006 Long Term Debt to Equity Ratio = 3531.63/-7152.90
= -0.49:1
The equity has gone negative in 2006 which means there has been huge losses. Hence the company is facing solvency issues.
Times Interest Earned Ratio = Earning Before Interest and Tax/ Interest Charges
2004 Times Interest Earned Ratio = 1659.84/1516.90
= 1.094 times
2006 Times Interest Earned Ratio = 1907.84/1288.29
= 1.481 times
The ratio has increased but still the ratio is less than twice which means the company is paying huge interest.
Cash From Operations to Total Debt = Operating Cash flow/Total debt
2004 Cash From Operations to Total Debt = 19.89/(17150.81+1033.96)
= 0.0019%
2006 Cash From Operations to Total Debt = 335.98/(4568.83+3531.63)
= 0.04%
Free Operating Cash Flow to Debt = (Cash from operating + Interest - Capital Expenditure)/ Total Debt
2004 Free Operating Cash Flow to Debt = (19.89+1516.90-1545.48)/ (17150.81+1033.96)
= -0.00048%
2006 Free Operating Cash Flow to Debt = (335.98+1288.29-211.50)/(4568.83+3531.63)
= 0.174%
b. 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 decreased in the past two years. Along with the Interest Coverage ratios that are exceedingly low , the probability that the company will face default has significantly increased.
The Current Ratio and Quick Ratio for 2006 have decreased by 0.469 and 0.294. Further, the Interest Coverage Ratios are exceedingly low hence the company may face default.
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