Question

Compute and Interpret Z-score

Balance sheets and income statements for Lockheed Martin Corporation follow. Refer to these financial statements to answer the requirements.

Income Statement
Year Ended December 31 (In millions)	2005	2004	2003
Net sales
Products	$ 31,518	$ 30,202	$ 27,290
Service	5,695	5,324	4,534
	37,213	35,526	31,824
Cost of sales
Products	28,800	27,879	25,306
Service	5,073	4,765	4,099
Unallocated coporate costs	803	914	443
	34,676	33,558	29,848
	2,537	1,968	1,976
Other income (expenses), net	449	121	43
Operating profit	2,986	2,089	2,019
Interest expense	370	425	487
Earnings before taxes	2,616	1,664	1,532
Income tax expense	791	398	479
Net earnings	$ 1,825	$ 1,266	$ 1,053

Balance Sheet
December 31 (In millions)	2005	2004
Assets
Cash and cash equivalents	$ 2,244	$ 1,060
Short-term investments	429	396
Receivables	4,579	4,094
Inventories	1,921	1,864
Deferred income taxes	861	982
Other current assets	495	557
Total current assets	10,529	8,953
Property, plant and equipment, net	3,924	3,599
Investments in equity securities	196	812
Goodwill	10,447	9,892
Purchased intangibles, net	560	672
Prepaid pension asset	1,360	1,030
Other assets	2,728	2,596
Total assets	$ 29,744	$ 27,554
Liabilities and stockholders' equity
Accounts payable	$ 1,998	$ 1,726
Customer advances and amounts in excess of costs incurred	4,331	4,028
Salaries, benefits and payroll taxes	1,475	1,346
Current maturities of long-term debt	202	15
Other current liabilities	1,422	1,451
Total current liabilities	9,428	8,566
Long-term debt	4,784	5,104
Accrued pension liabilities	2,097	1,660
Other postretirement benefit liabilities	1,277	1,236
Other liabilities	2,291	1,967
Stockholders' equity
Common stock, $1 par value per share	432	438
Additional paid-in capital	1,724	2,223
Retained earnings	7,278	7,915
Accumulated other comprehensive loss	(1,553)	(1,532)
Other	(14)	(23)
Total stockholders' equity	9,867	9,021
Total liabilities and stockholders' equity	$ 29,744	$ 27,554

Consolidated Statement of Cash Flows
Year Ended December 31 (In millions)	2005	2004	2003
Operating Activities
Net earnings	$ 1,825	$ 1,266	$ 1,053
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization	555	511	480
Amortization of purchased intangibles	150	145	129
Deferred federal income taxes	24	(58)	467
Changes in operating assets and liabilities:
Receivables	(390)	(87)	(258)
Inventories	(39)	519	(94)
Accounts payable	239	288	330
Customer advances and amounts in excess of costs incurred	296	(228)	(285)
Other	534	568	(13)
Net cash provided by operating activities	3,194	2,924	1,809
Investing Activities
Expenditures for property, plant and equipment	(865)	(769)	(687)
Acquisition of business/investments in affiliated companies	(564)	(91)	(821)
Proceeds from divestiture of businesses/Investments in affiliated companies	935	279	234
Purchase of short-term investments, net	(33)	(156)	(240)
Other	28	29	53
Net cash used for investing activities	(499)	(708)	(1,461)
Financing Activities
repayment of long-term debt	(133)	(1,089)	(2,202)
Issuances of long-term debt	--	--	1,000
Long-term debt repayment and issuance costs	(12)	(163)	(175)
Issuances of common stock	406	164	44
Repurchases of common stock	(1,310)	(673)	(482)
Common stock dividends	(462)	(405)	(261)
Net cash used for financing activities	(1,511)	(2,166)	(2,076)
Net increase (decrease) in cash and cash equivalents	1,184	50	(1,728)
Cash and cash equivalents at beginning of year	1,060	1,010	2,738
Cash and cash equivalents at end of year	$ 2,244	$ 1,060	$ 1,010

As of December 31, there were the approximate shares outstanding:
2005 - 434,264,432
2004 - 440,445,630

As of December 31, the company's stock closed at the following values:
2005 - $63.63
2004 - $55.55

(a) Compute and compare the Altman Z-scores for both years. (Do not round until your final answer; then round your answers to two decimal places.)
2005 z-score = Answer
2004 z-score = Answer

Which of the following explain the trend in the Z-scores from 2004 to 2005? (Select all that apply.)
Answeryesno The market value of Lockheed's equity improved somewhat over the year.
Answeryesno Lockheed decreased its liquidity due to an increase in retained earnings.
Answeryesno Lockheed improved its short-term liquidity by increasing cash.
Answeryesno Lcokheed improved its long-term liquidity by decreasing total liabilities.

(b) Which of the following statements best describes the company's Altman Z-scores?

The Altman Z-scores have increased from 2004 to 2005 which indicates the company's bankruptcy risk has decreased. YES? OR NO

Both the Altman Z-scores are above 3.00 which indicate the company has a very low probability of bankruptcy. YES? OR NO

Both the Altman Z-scores are below 1.80 which indicate the company has a very high probability of bankruptcy. YES? OR NO

The Altman Z-scores have decreased from 2004 to 2005 which indicates the company's bankruptcy risk has increased. YES? OR NO

Answer 1

(a) Computation of Altman Z-scores for 2004 and 2005:

Formula for Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

Where,

A = working capital / total assets

B = retained earnings / total assets

C = earnings before interest and tax / total assets

D = market value of equity / total liabilities

E = sales / total assets

Therefore,

2004 Z-score = 1.2(0.014045148) + 1.4(0.287254119) + 3.3(0.075814764) +                                                                                          0.6(0.887956549) + 1(1.289322784)

                                                = 2.491295

2005 Z-score = 1.2(0.037015869) + 1.4(0.244688004) + 3.3(0.100389995) +                                                         0.6(0.929002347) + 1(1.251109467)

                        = 2.52678

Trend in the Z-scores from 2004 to 2005:

• Yes. The market value of Lockheed’s equity improved somewhat over the year.The market value of is $27632.24581(in millions) in 2005 as against $24466.75475 (in millions) in 2004.
• No. Lockheed’s retained earnings has not increased from 2004 to 2005.
• Yes. Lockheed increased its short term liquidity by increasing cash ($1060 millions in 2004 to $2244 millions in 2005).
• No. Lockheed total liabilities has increased from 2004 to 2005. It has not improved its long term liquidity.

Workings for answer (a):

	2004	2005
A=working capital/total assets	0.014045148	0.037015869
B=retained earnings/total assets	0.287254119	0.244688004
C=earnings before interest and tax/total assets	0.075814764	0.100389995
D=market value of equity/total liabilities	0.887956549	0.929002347
E=sales/total assets	1.289322784	1.251109467

Computation workings for A:	2004	2005
Total current assets	8953	10529
Total current liabilities	8566	9428
Working capital=Total current assets - total current liabilities	387	1101
Total assets	27554	29744
Therefore, A=working capital/total assets	0.014045148	0.037015869

Computation workings for B:	2004	2005
Retained earnings	7915	7278
Total assets	27554	29744
B=retained workings/total assets	0.287254119	0.244688004

Computation workings for C:	2004	2005
Earnings before interest and tax	2089	2986
Total assets	27554	29744
C=earnings before interest and tax/total assets	0.075814764	0.100389995

Computation workings for D:	2004	2005
Shares outstanding	440445630	434264432
Market value (in $)	55.55	63.63
Market value of equity (in millions) = shares outstanding*market value	24466.75475	27632.24581
Total liabilities	27554	29744
D=market value of equity/total liabilities	0.887956549	0.929002347

Computation workings for E:	2004	2005
Sales	35526	37213
Total assets	27554	29744
E=sales/total assets	1.289322784	1.251109467

*Note : All financial figures in millions.

(b)

• Yes. The Altman Z-scores have increased from 2004 to 2005 which indicates that the company’s bankruptcy risk has decreased. This is the statement that best describes the company’s Altman Z-scores.
• No. Both the Altman Z-scores are below 3.00
• No. Both the Altman Z-scores are above 1.80
• No. The Altman Z-scores have not decreased from 2004 to 2005.