Bixton Company’s new chief financial officer is evaluating Biston’s capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here.
Rating Category Fixed Charge Coverage Funds From Operations/Total Debt Long-Term Debt/Capitalization
Aa 4.00-5.25x 60-80% 17-23%
A 3.00-4.30 45-65% 22-32%
Baa 1.95-3.40 35-55% 30-41%
A. Bixton’s objective is to achieve a credit standing that falls, in the words of the chief financial officer, “comfortably within the “A” range. What target range would you recommend for each of the three credit measures?
Fixed Charge Coverage 3.00-4.30
Funds From Operations/Total Debt 45-65%
Long-Term Debt/Capitalization 22-32%
To ensure a rating that is “comfortably within the A range”, the company should try to maintain a fixed ratio of 4-4.3%, funds from operations/total debt between 60-65% and a lower long-term debt/capitalization ratio between 22-24%.
B. Before settling on these target ranges, what other factors should Bixton’s chief financial officer consider?
1. Does the company have the ability to fully utilize non-interest tax credits?
2. Does the company have the ability to raise debt from the markets?
3. Does the company have the appropriate level of income to absorb the cost associated with the issuance of the debt?
4. Does the company have the appropriate level of income to absorb the cost associated with the future fixed expense of interest payments?
5. What effect will raising debt have on consumer outlook?
C. Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve?
Even though the firm has larger-than-average research and development and foreign tax credits