For private firm, Altman adjusts the public model by changing the numerator for the variable X4 from the market value of equity to the book value of equity. The revised model follows: Z = .717 (X1) + .847 (X2) + 3.11 (X3) + .420 X4 + .998 (X5) Where: X1 = Net Working Capital/Total assets X2 = Retained Earnings/Total Asset X3 = Earnings before interest and taxes/Total Assets X4 = Book value of equity/Book value of Total Liabilities X5 = Sales/Total Assets The model predict bankruptcy when Z < 1.23. The range between 1.23 and 2.90 is labeled the “grey area”. The following table presents the independent variables from the three companies at the end of 2011. a) Calculate Altman Z-score for each company and interpret the results. b) Calculate the debt ratio for each of the companies. c) Explain the impact of increase debt ratio to Altman Z-score.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
For private firm, Altman adjusts the public model by changing the numerator for the variable X4 from the market value of equity to the book value of equity. The revised model follows:
Z = .717 (X1) + .847 (X2) + 3.11 (X3) + .420 X4 + .998 (X5)
Where:
X1 = Net Working Capital/Total assets
X2 =
X3 = Earnings before interest and taxes/Total Assets
X4 = Book value of equity/Book value of Total Liabilities
X5 = Sales/Total Assets
The model predict bankruptcy when Z < 1.23. The range between 1.23 and 2.90 is labeled the “grey area”.
The following table presents the independent variables from the three companies at the end of 2011.
a) Calculate Altman Z-score for each company and interpret the results.
b) Calculate the debt ratio for each of the companies.
c) Explain the impact of increase debt ratio to Altman Z-score.
Step by step
Solved in 6 steps
