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[QUESTION] [Problem 16.8] Boehm-Gau Real Estate Speculators, Inc., and the Northern California Electric Utility Company have the following EBIT and debt-servicing burden: The tax rate for Boehm-Gau is 40 percent, and for Northern California Electric Utility is 36 percent. Compute the interest coverage and the debt-service coverage ratios for the two companies. With which company would you feel more comfortable if you were a lender? Why? [ANSWER] (000s omitted) Boehm-Gau : Interest Coverage = $5,000 / $1,600 = 3.13 Debt-service Coverage = Northern California: Interest Coverage = $100,000 / $45,000 = 2.22 The question of with which company one feels more comfortable depends on the business risk. Inasmuch as an electric utility has stable cash flows and Northern California is large, it is no doubt the

safer loan despite the lower coverage ratios. The fact that the debt- service coverage ratio is 1.0 means that some of the debt will probably have to be renewed or “rolled over” at maturity. However, this is typical for an electric utility.

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