CCP Credit Analysis & Risk Assessment 2 — Questions and Answers
Question 1: A borrower's EBITDA is $500,000 and total debt is $3,000,000. What is the Debt/EBITDA ratio, and how is it generally interpreted?
- 6x, indicating high leverage and elevated repayment risk (Correct answer)
- 0.6x, indicating low leverage and strong repayment capacity
- 16.7%, indicating a moderate debt burden relative to earnings
- 3x, indicating acceptable leverage for most industries
Correct answer: 6x, indicating high leverage and elevated repayment risk
Debt/EBITDA of 6x means it would take 6 years of EBITDA to retire the debt, which is considered high leverage and signals elevated credit risk.
Question 2: Which qualitative factor is MOST critical when assessing the credit risk of a small, owner-operated business?
- Key-person dependency and management succession plan (Correct answer)
- The company's advertising budget
- Number of employees on payroll
- Square footage of the business premises
Correct answer: Key-person dependency and management succession plan
Owner-operated businesses face key-person risk; if the owner is incapacitated, the business may not survive, making succession planning a critical qualitative factor.
Question 3: What does a declining Current Ratio over three consecutive fiscal years most likely signal to a credit analyst?
- Deteriorating short-term liquidity and potential cash flow stress (Correct answer)
- Improving asset efficiency and leaner inventory management
- Increased long-term investment in capital expenditures
- Stronger profitability driven by higher sales volume
Correct answer: Deteriorating short-term liquidity and potential cash flow stress
A consistently declining Current Ratio indicates that current liabilities are growing faster than current assets, signaling worsening short-term liquidity.
Question 4: Under the concept of 'sensitivity analysis' in credit risk, what is the primary purpose?
- To test how changes in key assumptions (e.g., revenue decline) affect debt serviceability (Correct answer)
- To rank borrowers by their credit scores from highest to lowest
- To determine the market value of collateral pledged against a loan
- To calculate the net present value of future loan cash flows
Correct answer: To test how changes in key assumptions (e.g., revenue decline) affect debt serviceability
Sensitivity analysis stress-tests financial projections by varying key inputs to assess how much deterioration a borrower can absorb before defaulting.
Question 5: A company has net sales of $2,000,000 and average accounts receivable of $400,000. What is its Days Sales Outstanding (DSO)?
- 73 days (Correct answer)
- 5 days
- 20 days
- 50 days
Correct answer: 73 days
DSO = (Average AR / Net Sales) × 365 = (400,000 / 2,000,000) × 365 = 73 days, indicating how long it takes to collect receivables.
Question 6: Which credit risk concept describes the potential loss a lender faces if a borrower defaults, taking into account collateral recovery?
- Loss Given Default (LGD) (Correct answer)
- Probability of Default (PD)
- Exposure at Default (EAD)
- Expected Loss (EL)
Correct answer: Loss Given Default (LGD)
LGD represents the proportion of exposure a lender loses after recovering proceeds from collateral or guarantees following a default.
Question 7: When analyzing a borrower in a cyclical industry (e.g., construction), which approach is MOST appropriate for spreading financials?
- Average performance across a full business cycle, not just peak-year financials (Correct answer)
- Use only the most recent year's financials for current relevance
- Rely exclusively on projected financials provided by management
- Focus solely on the balance sheet and ignore income statement trends
Correct answer: Average performance across a full business cycle, not just peak-year financials
Cyclical industries require through-the-cycle analysis to avoid over-weighting peak earnings that will not persist through downturns.
CCP Credit Analysis & Risk Assessment 2
A borrower's EBITDA is $500,000 and total debt is $3,000,000.
What is the Debt/EBITDA ratio, and how is it generally interpreted?