CU Financial and Credit Analysis 3 — Questions and Answers
Question 1: Which depreciation method results in the highest net income in the early years of an asset's life?
- Double declining balance
- Sum-of-the-years-digits
- Straight-line (Correct answer)
- Units of production
Correct answer: Straight-line
Straight-line depreciation spreads costs evenly, producing lower early depreciation expense and therefore higher net income compared to accelerated methods.
Question 2: A borrower's EBITDA is $500,000 and total debt is $3,000,000. What is the debt-to-EBITDA ratio, and how would a typical underwriter interpret it?
- 0.17x — very low leverage, strong credit quality
- 6.0x — high leverage, potentially concerning (Correct answer)
- 0.60x — moderate leverage, acceptable
- 3.0x — low leverage, comfortable coverage
Correct answer: 6.0x — high leverage, potentially concerning
A debt-to-EBITDA of 6.0x ($3,000,000 / $500,000) is considered high leverage and raises repayment risk concerns for most lenders.
Question 3: Which component of the Five C's of Credit evaluates the borrower's track record and reliability in meeting past obligations?
- Capital
- Capacity
- Character (Correct answer)
- Conditions
Correct answer: Character
Character refers to the borrower's credit history, reputation, and demonstrated willingness to repay debts as agreed.
Question 4: An underwriter notices that a company's inventory days outstanding has increased significantly year-over-year. What is the most likely concern?
- The company is collecting receivables too slowly
- Inventory may be obsolete, overstocked, or demand is weakening (Correct answer)
- The company is aggressively paying down accounts payable
- The company's gross margin has improved substantially
Correct answer: Inventory may be obsolete, overstocked, or demand is weakening
Rising inventory days can indicate slowing sales, overproduction, or obsolescent stock, all of which may impair cash conversion and liquidity.
Question 5: Under the indirect method of the cash flow statement, which adjustment is made to reconcile net income to operating cash flow?
- Subtract depreciation and amortization
- Add back depreciation and amortization (Correct answer)
- Subtract capital expenditures
- Add proceeds from long-term borrowings
Correct answer: Add back depreciation and amortization
Depreciation and amortization are non-cash charges deducted in arriving at net income, so they are added back under the indirect method.
Question 6: A lender requires a personal guarantee on a commercial loan. This primarily addresses which of the Five C's?
- Conditions
- Capital
- Collateral (Correct answer)
- Capacity
Correct answer: Collateral
A personal guarantee enhances collateral by giving the lender recourse to the guarantor's personal assets if the business defaults.
Question 7: Which financial statement analysis technique involves expressing each income statement line item as a percentage of net revenues?
- Horizontal analysis
- Trend analysis
- Vertical (common-size) analysis (Correct answer)
- Ratio analysis
Correct answer: Vertical (common-size) analysis
Vertical analysis converts income statement figures to percentages of revenue, enabling comparison across periods and against industry peers regardless of size.
CU Financial and Credit Analysis 3
Which depreciation method results in the highest net income in the early years of an asset's life?