Project 11 / Ristafany Pahlevi / S 4310015
E18.1 Balance Sheet and Risk
Below are balance sheet for two firms with similar revenues. Amounts are in million of dollars.
Which firm looks more risky for shareholders ? Why ?
Firm A
Assets Liabilitries and Equity
Cash $ 17 Account payable $ 14
Account receivable 43 Long term debt 200
Inventory 102
Property, plant, and equipment 194
Long term debt investment 104 Common equity 246
$460 $460
Firm B
Aseets Liablitiies and Equity
Cash $ 15 Account payable $ 37
Account receivable 72 Long term debt 200
Inventory 107
Property, plant, and equipment 289 Common equity 246
$483 $ 483
Firm A looks more risky than Firm B, because Firm A has long term debt investment that is
risky for the firm. If that investment doesn’t give firm return like they are expected, so tha firm
will gain loss.
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Project 11 / Ristafany Pahlevi / S 4310015
E18.2 Income Statement and Risk
The statements below are for two firms in the same line of business.
Firm A Firm B
Sales $1,073 Sales $1,129
Expenses Expenses
Labor and material $ 536 Labor and material $793
Administration 121 Administration 42
Depreciation 214 Depreciation 79
Selling expenses 84 Selling expenses 91
955 1,005
118 124
Interest expenses 25 4
Income before taxes 93 120
Income taxes 34 43
Income after tax $ 59 $ 77
a) Analyze the risk drivers in these income statements. Which firm looks more risky for
stockholders ? why ?
ROCE Risk
Firm A Firm B
Profit margin = Income after tax / sales = $59 / $1,073 = $77 / $1,129
= 0.055 = 0.068
Expense risk = expense / sales = $955 / $1,073 = $1,005 / $1,129
= 0.89 = 0.26
Operating leverage risk = fixed cost / variable = $419 / $536 = $212 / $793
= 0.78 = 0.27
b) On the basis of the relationships in these income statements, develop pro forma income
statements under the following scenarios :
2
Project 11 / Ristafany Pahlevi / S 4310015
Sales dropped to $532 million
Firm A Firm B
Sales $532 $532
Expenses
Labor and material $ 536 $793
Administration 121 42
Depreciation 214 79
Selling expenses 84 91
955 1,005
(423) (473)
Interest expenses ( 25) ( 4)
Loss before taxes (448) (477)
Sales increase to $2,140 million
Firm A Firm B
Sales $2,140 $2,140
Expenses
Labor and material $ 536 $793
Administration 121 42
Depreciation 214 79
Selling expenses 84 91
955 1,005
Income before tax 1,185 1,135
Income tax ( 34) ( 43)
Income after tax 1,151
1,092
3
Project 11 / Ristafany Pahlevi / S 4310015
E19.1 Credit Scoring : A decline in Credit Quality ?
The following numbers are extracted from the financial statements for a firm for 2008 and 2009.
Amounts are in millions of dollars.
2008 2009
Sales 4,238 3,276
Earnings before interest and taxes 154 (423)
Current assets 1,387 976
Current liabilities 1,292 1,390
Total assets 3,245 3,098
Book of value of shareholders’ equity 1,765 1,388
Retained earnings 865 488
At the end of 2008, the firm’s 80 million shares traded a $25 each, but by the end of 2009 they
traded at $15. Commentators blamed the drop on an increase in the risk of bankruptcy. Conduct a
credit scoring analysis the indicates how much the likelihood of bankruptcy increase over the
year.
2008 = 1,2 (1,387/3,245) + 1,4 (865/3,245) + 3,3 (154/3,245) + 0,6 (4,200/1,292) + 1
(4,238/3,245)
= 1,6223 + 0,373 + 0,1566 + 1,9505 + 1,306
= 5,4084
2009 = 1,2 (976/3,098) + 1,4 (488/3,096) + 3,3 ((423)/3,096) + 0,6 (976/3,096) + 1
(3,276/3,096)
= 0,378 + 0,2206 – 0,4508 + 0,518 + 1,058
= 1,7238
Logit analysis
Y = -1,32 – 0,407 + 6,03 (1,390/3,098) – 1,43 (976/3,098) + 0,0757 (1,390/976) –
2,37 ((423)/3,098) – 1,83 (976/1,390) – 0,285 (1) – 1,72 (1) – 0,521 ((269)/269)
= -1,32 – 0,407 + 2,7055 – 0,4505 + 0,1078 + 0,1365 – 1,285 – 0,285 – 1,72 +
0,521
= -1,9977
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Project 11 / Ristafany Pahlevi / S 4310015
Probability of bankcruptcy = 1 / 1 + 2,7182821,9977
= 1 / 1 + 7,372081728
= 0,11944
E19.3 Yield-to-Maturity and Required Bond Returns
After analyzing the default risk for a five-year bond with a maturity value of $1,000 and an 8%
annual coupon, an analyst estimates the required return for the bond at 7% peryear. The bond has
just been issued at a price of $1,000.
a. What is the value of the bond at a 7% required return ?
b. What is the yield-to-maturitywith a market price of $1,000 ?
c. What is the expected return of buying the bond at a price of $1,000 ?
d. Does the analyst thing that the bond is appropriately priced by the bond market ?
E19.4 Z-Scoring
Below are ratio for some of the firms that have appeared in this book, for their 1998 fiscal year.
Firm Working Retained Earnings Market Value Sales /
Capital / Earnings / Before of Equity / Total
Total Assets Total Assets Interest and Book Value of Assets
Taxes / Liabilities
Total Assets
Coca-cola -0,12 1,05 0,29 15,4 0,98
Nike 0,34 0,58 0,15 9,0 1,67
Reebok 0,43 0,66 0,06 0,7 1,85
Hewlett- 0,24 0,50 0,13 3,6 1,40
Packard
Dell, Inc 0,38 0,09 0,31 27,9 2,65
Gateway 0,27 0,34 0,19 5,2 2,59
Computer
Microsoft 0,45 0,34 0,32 46,7 0,65
a. Calculate Z-scores from these ratios
Coca-cola = 1,2 (-0,12) + 1,4 (1,05) + 3,3 (0,29) + 0,6 (15,4) + 1,0 (0.98)
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Project 11 / Ristafany Pahlevi / S 4310015
= -0,144 + 1,47 + 0,957 + 9,24 + 0,98
= 12,503
Nike = 0,408 + 0,812 + 0,495 +5,4 +1,67
= 8,785
Reebok = 0,516 +0,924 + 0,198 + 0,42 + 1,85
= 3,908
Hewlett – Packard = 0,288 + 0,7 + 0,429 + 2,16 + 1,4
= 4,977
Dell, Inc = 0,456 + 0,126 +1,023 +16,74 +2,65
= 20,995
Gateway Computer = 0,324 + 0,476 + 0,627 + 3,12 + 2,96
= 7,137
Microsoft = 0,54 + 0,476 +1,056 + 28,02 + 0,65
= 30,742
b. Explain why nike has a different Z-Score from Reebok
c. What reservation do you have about the Z-Score as an Indicator of Creditworthiness?
