hard · Corporate Credit Analysis
An analyst is reconciling why a company with strong reported net income of $180M and reported leverage of 3.0x is nonetheless burning cash. Notes reveal: (a) days sales outstanding rose from 45 to 75 days on flat revenue of $1,200M; (b) the firm factored $100M of receivables with recourse near year-end, recording it as a sale that reduced reported debt; (c) capitalized interest of $40M was excluded from interest expense; (d) it switched from accelerated to straight-line depreciation, raising net income.
Which single adjustment most materially distorts the reported 3.0x leverage and should be reversed first?
- Reversing the capitalized $40M of interest, since it understates the true interest burden used in coverage ratios
- Adding back the $100M of recourse factoring to debt, since the recourse retains the credit risk and the 'sale' is economically secured borrowing
- Reversing the depreciation-method change, since straight-line inflates net income and thus understates leverage
- Capitalizing the receivables growth from the DSO increase as a non-cash working-capital drag that should be added to debt
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