Investments, tenth edition

 Table 14.3 

 Financial ratios by rating class, long-term debt 

  Note: EBITDA is earnings before interest, taxes, depreciation, and amortization  

 Source:  Corporate Rating Criteria,  Standard & Poor’s, 2006. 

  

  3-year medians  

  

  AAA  

  AA  

  A  

  BBB  

  BB  

  B  

  CCC  

 EBIT interest coverage multiple 

 23.8  

19.5  

8.0  

4.7  

2.5  

1.2  

0.4 

 EBITDA interest coverage multiple 

 25.5  

24.6  

10.2  

6.5  

3.5  

1.9  

0.9 

 Funds from operations/total debt (%) 

 203.3  

79.9  

48.0  

35.9  

22.4  

11.5  

5.0 

 Free operating cash flow/total debt (%) 

 127.6  

44.5  

25.0  

17.3  

8.3  

2.8  

(2.1) 

 Total debt/EBITDA multiple 

 0.4  

0.9  

1.6  

2.2  

3.5  

5.3  

7.9 

 Return on capital (%) 

 27.6  

27.0  

17.5  

13.4  

11.3  

8.7  

3.2 

 Total debt/total debt  1  equity (%) 

 12.4  

28.3  

37.5  

42.5  

53.7  

75.9  

113.5 

ROE

Coverage Ratio

 Figure 14.9 

Discriminant analysis  

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472 

P A R T   I V

 Fixed-Income 

Securities

 Altman found the following equation to best separate failing and nonfailing firms:   

Z

5 3.1

 

EBIT

Total assets

1 1.0

 

Sales

Assets

1 .42

 

Shareholders’ equity

Total liabilities

 

1 .85

 

Retained earnings

Total assets

1 .72

 

Working capital

Total assets

  

 where  EBIT  5  earnings before interest and taxes.  

13

    Z -scores below 1.23 indicate vulner-

ability to bankruptcy, scores between 1.23 and 2.90 are a gray area, and scores above 2.90 

are considered safe.   

   

13

 Altman’s original work was published in Edward I. Altman, “Financial Ratios, Discriminant Analysis, and the 

Prediction of Corporate Bankruptcy,”  Journal of Finance  23 (September 1968). This equation is from his updated 

study,  Corporate Financial Distress and Bankruptcy,  2nd ed. (New York: Wiley, 1993), p. 29. Altman’s analysis 

is updated and extended in W. H. Beaver, M. F. McNichols, and J-W. Rhie, “Have Financial Statements become 

Less Informative? Evidence from the Ability of Financial Ratios to Predict Bankruptcy,”  Review of Accounting 

Studies  10 (2005), pp. 93–122.  

  

14

 Although it is less common, the sinking fund provision also may call for periodic payments to a trustee, with the 

payments invested so that the accumulated sum can be used for retirement of the entire issue at maturity. 

 Suppose we add a new variable equal to current liabilities/current assets to Altman’s 

equation. Would you expect this variable to receive a positive or negative coefficient? 

 CONCEPT CHECK