Question

Using the financial information below, calculate company XYZ's Altman Z score. Enter your answer as a number with three decimal places of precision (i.e. 1.234).

Answer 1

In 1968, The Altman Z-Score was devised by Edward Altman, the New York University professor for predicting financial liquidity position. Z score is a multivariate analysis based on accounting data that measures the financial health of the companies and helps in predicting financial distress. It is a statistical tool used to measure the likelihood that a company will go bankrupt.

This model is based on 5 ratios namely: 1) Liquidity 2) Profitability 3) Financial Leverage 4) Solvency 5) Activity Ratios

The evaluation criteria was that the companies with lower Z score than the cutoff point indicate higher distress risk, the companies with Z score greater than cutoff was classified as safe. The area between lower and higher cutoff point was called grey area

ZONE	Z
Safe zone	Z>2.99
Grey Zone	1.81<Z<2.99
Distress Zone	Z<1.81

The Standard Z-Score

The formula for the Z-Score (which incorporates those seven simple pieces of data) is:

Z-Score = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6) + ([Sales / Total Assets] x 0.999)

in above question , we will calculate the following ratios:

1) Working capital/ Total assets:

Working Capital= Current Assets- Current liabilities

= (cash + Inventory + Account Receivable) - ( Accounts payable + Notes payable)

= (25+90+85) - ( 30+90) = 200 - 120 = 80

Total Assets = Cash + Account receivable + inventory + Plant and equipment

= 25+85+90+ 500 = 700

working capital/ Total assets = 80/700 = 0.1142

2) Retained earning/ Total assets:

Retained earning = 22

Total assets = Cash + Account receivable + inventory + Plant and equipment

= 25+85+90+ 500 = 700

Retained Earning/ Total Assets = 22/700 = 0.031

3) Operating Earnings/ Total Assets:

Operating earning/ Income = Sales - Cost of goods sold

= 445-305 = 140

Total assets = 700

Operating Earning/ Total assets = 140/700 = 0.2

4) Market capitalization / Total liabilities :

Market capitalization = 400

Total liabilities= Accounts payable + Notes payable + Accruals + long term debt

  = 30+90+25+155 = 300

Market capitalization/ Total liabilities = 400/300 = 1.333

5) Sales / Total Assets:

Sales = 445

Total Assets = 700

Sales/total assets = 445/700 = 0.635

Now using these values in the Z formula ,

Z-Score = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6) + ([Sales / Total Assets] x 0.999)

= (0.1142* 1.2) + (0.031* 1.4) + (0.2* 3.3) + (1.333 * 0.6) + (0.635 * 0.999)

= 0.1370 + 0.0434 + 0.66 + 0.7998 + 0.6343

= 2.274

it lies in the Grey zone

Grey Zone

1.81<Z<2.99