On October 31, 2007, Sterling Construction Company entered into a credit agreement with Comerica Bank. The following appeared among the agreement's financial covenants: "Commencing with the fiscal quarter ending December 31, 2007, maintain as of the end of each fiscal quarter a Fixed Charge Coverage Ratio of not less than 1.25 to 1.00." The credit agreement also contained a "definitions" section where this item was listed: " ‘Fixed Charge Coverage Ratio' shall mean as of any date of determination a ratio the numerator of which is EBITDA for the Applicable Measuring Period, minus cash taxes and cash tax distributions with respect to such period and the denominator of which is the sum of Current Maturities of Long Term Debt plus interest paid during the trailing twelve month period, plus twenty-five percent (25%) of the daily average total non-amortizing debt during the trailing twelve month period."
a. What is a minimum fixed charge coverage ratio and what purpose does it serve in the company's loan agreements?
b. Why is it necessary for the loan agreement to precisely define "Fixed Charge Coverage Ratio?"
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