Project 11 / Ristafany Pahlevi / S 4310015 431 0015 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 Cash Account receivable
Liabilitries and Equity $ 17 43
Inventory
1 02
Property, plant, and equipment
1 94
Long term debt investment
1 04
Account payable
$ 14
Long term debt
20 0
Common equity
24 6
$ 4 60
$4 6 0
Firm B
Aseets Cash Account receivable
Liablitiies and Equity $ 15 72
Inventory
1 07
Property, plant, and equipment
2 89 $ 4 83
Account payable
$ 37
Long term debt
20 0
Common equity
24 6 $ 4 83
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
Expenses Labor and material
$1,129
Expenses $ 536
Labor and material
$793
Administration
121
Administration
42
Depreciation
214
Depreciation
79
Selling expenses
91
Selling expenses
84 955
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
Profit margin = Income after tax / sales
Expense risk = expense / sales
Operating leverage risk = fixed cost / variable
Firm A
Firm B
= $59 / $1,073
= $77 / $1,129
= 0.055
= 0.068
= $955 / $1,073
= $1,005 / $1,129
= 0.89
= 0.26
= $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 :
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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
84
91
Selling expenses
Interest expenses Loss before taxes
955
1,005
(423)
(473)
( 25)
( 4)
(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
84
91
Selling expenses
955
1,005
Income before tax
1,185
1,135
Income tax
( 34)
( 43)
Income after tax
1,151
1,092
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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
4,238
3,276
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
865
488
Sales Earnings before interest and taxes
Retained earnings
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 4
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
Coca-cola
-0,12
Total Assets 0,29 15,4 0,58 0,15 0,06 0,7 0,13 3,6
Reebok Hewlett-
0,43 0,24
1,05 0,34 0,66 0,50
Packard Dell, Inc Gateway
0,38 0,27
0,09 0,34
0,31 0,19
27,9 5,2
2,65 2,59
Computer Microsoft
0,45
0,34
0,32
46,7
0,65
Nike
a.
0,98 9,0
1,67 1,85 1,40
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) 5
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?
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