Question

total assets are worth $3,500,000 while they have a working capital of $4,200,000. Their liabilities stand at $5,000,000 while retained earnings amount to $800,000. Earnings Before Interest and Tax come to $6,500,000. Sales total $8,300,000 while the market value of equity is $7,000,000.

Find Altman Z score , and explain the level of this score

Answer 1

Solution:

Given:

Total Assets = $ 3,500,000

Working Capital = $ 4,200,000

Liabilities = $ 5,000,000

Retained Earnings = $ 800,000

Earnings Before Interest and Taxes = $ 6,500,000.

Total Sales = $ 8,300,000

The Market Value of Equity = $ 7,000,000.

To Calculate:

Altman Z Score along with explanation of the level of the score.

Formula: Altman Z Score:

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1X5

Where:

Z = Altman Z Score

X1 = Working Capital / Total Assets

X2 = Retained Earnings / Total Assets

X3 = Earnings Before Interest & Tax (EBIT) / Total Assets

X4 = Market Capitalization or Market Value of Equity / Total Liabilities

X5 = Sales / Total Assets

Process- Calculations:

Step:1 Calculation of the Values of X1, X2, X3, X4 & X5:

Tabulation of Calculation of Values of X1 to X5:

	Formula	Calculations	Final Values
X1	X1 = Working Capital / Total Assets	$ 4,200,000 / $ 3,500,000 = 1.2	X1 = 1.2
X2	X2 = Retained Earnings / Total Assets	$ 800,000 / $ 3,500,000 = 0.23	X2 = 0.23
X3	X3 = Earnings Before Interest & Tax (EBIT) / Total Assets	$ 6,500,000 / $ 3,500,000 = 1.86	X3 = 1.86
X4	X4 = Market Capitalization or Market Value of Equity / Total Liabilities	$ 7,000,000 / $ 5,000,000 = 1.4	X4 = 1.4
X5	X5 = Sales / Total Assets	$ 8,300,000 / $ 3,500,000 = 2.37	X5 = 2.37

From the calculations of above table, we get the values of X1 to X5 as follows:

X1 = 1.2, X2 = 0.23, X3 = 1.86, X4 = 1.4, X5 = 2.37

Step: 2 Calculation of the Value of Altman Z Score:

Formula:

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1X5

Here:

X1 = 1.2, X2 = 0.23, X3 = 1.86, X4 = 1.4, X5 = 2.37

On putting these values in the Z Score Formula, we get,

Z = (1.2 × 1.2) + (1.4 × 0.23) + (3.3 × 1.86) + (0.6 ×1.4) + (1 × 2.37)

Z = 1.44 + 0.32 + 6.14 + 0.84 + 2.37

Z = 11.11

Altman Z Score, Z = 11.11

Levels of Altman Z Score:

1. Distress Zone: High Risk of Bankruptcy when Z < 1.23

2. Grey Zone: Uncertain Results about Bankruptcy when 1.23 < Z < 2.9

3. Safe Zone: Low Risk Area of Bankruptcy or Healthy Area when Z > 2.9

Conclusion:

Z = 11.11 falls in the level of Safe Zone i.e. at low risk of bankruptcy as 11.11 > 2.9 (Z > 2.9).

Since our Altman Z score is 11.11 which is considerably very high in the Safe Zone Area, as the minimum value required in the safe zone area is above 2.9. So, our company is in safe zone and is at least risk of bankruptcy. It is financially sound and healthy as per Altman Z Score. The financial position of the company is good. Investors will get definite profit by investing in the company.

Ans: Altman Z Score = 11.11, Level = Safe Zone Level