Problem:
The following is ABC Inc.'s balance sheet (in thousands):
|
Assets
|
|
Liabilities
|
|
|
Cash
|
$20
|
Accounts payable
|
$30
|
|
Accounts receivable
|
90
|
Notes payable
|
90
|
|
Inventory
|
90
|
Accruals
|
30
|
|
|
|
Long-term debt
|
150
|
|
Plant and equipment
|
500
|
Equity
|
400
|
|
Total
|
$700
|
|
$700
|
Also assume that sales equal $500, cost of goods sold equals $360, interest payments equal $62, taxes equal $56, and net income equals $22. Assume the beginning retained earnings is $0, the market value of equity is equal to its book value, and the company pays no dividends.
a. Calculate Altman's Z-score for ABC Inc. if ABC has a 50 percent dividend payout ratio and the market value of equity is equal to its book value. Recall the following:
Net working capital = Current assets – Current liabilities
Current assets = Cash + Accounts receivable + Inventories
Current liabilities = accounts payable + Accruals + Notes payable
EBIT = Revenues – Cost of goods sold – Depreciation
Taxes = (EBIT – Interest)(Tax rate)
Net income = EBIT – Interest – Taxes
Retained earnings = Net income (1 – Dividend payout ratio)
b. Should you approve ABC Inc.'s application to your bank for $500,000 for a capital expansion loan?
c. If ABC's sales were $450,000, taxes were $16,000, and the market value of equity fell to one-quarter of its book value (assume cost of goods sold and interest are unchanged), how would that change ABC's income statement? ABC's tax liability can be used to offset tax liabilities incurred by the other divisions of the firm. Would your credit decision change?
d. What are some of the shortcomings of using a discriminant function model to evaluate credit risk?