Question

A firm with lower interest coverage (EBIT/Interest Expense) and higher leverage (D/TA) should have a _________ credit rating (on its bonds) than a firm with higher interest coverage and lower leverage?

1) Higher
2) Lower
3) Same
4) Cannot be determined

Answer 1

A firm with lower interest coverage and higher leverage should generally have a lower credit rating, as these factors indicate a higher risk of default.

Step-by-step explanation:

A firm with lower interest coverage (EBIT/Interest Expense) and higher leverage (D/TA) should have a lower credit rating on its bonds than a firm with higher interest coverage and lower leverage. This is because a firm with lower interest coverage may have more difficulty meeting interest payments, and higher leverage indicates a greater debt relative to assets, which may increase the risk of default. Credit rating agencies such as Moody's assess the risk of a borrower defaulting on their debt obligations; a firm with lower interest coverage and higher leverage is considered riskier and, thus is likely to have a lower credit rating. Firms with high-profit records are likely to repay loans and thus attract better credit ratings