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	27,932	27,637	25,306
Service	5,073	4,765	4,099
Unallocated coporate costs	803	914	443
	33,808	33,316	29,848
	3,405	2,210	1,976
Other income (expenses), net	(449)	(121)	43
Operating profit	2,956	2,089	2,019
Interest expense	370	425	487
Earnings before taxes	2,586	1,664	1,532
Income tax expense	761	368	479
Net earnings	$ 1,825	$ 1,296	$ 1,053

Balance Sheet
December 31 (In millions)	2005	2004
Assets
Cash and cash equivalents	$ 2,144	$ 1,080
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	10,409	8,973
Property, plant and equipment, net	3,924	3,599
Investments in equity securities	196	812
Goodwill	8,447	7,892
Purchased intangibles, net	560	672
Prepaid pension asset	1,360	1,030
Other assets	2,728	2,596
Total assets	$ 27,624	$ 25,574
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	4,944	5,184
Accrued pension liabilities	1,617	1,760
Other postretirement benefit liabilities	1,277	1,236
Other liabilities	2,491	1,807
Stockholders' equity
Common stock, $1 par value per share	432	438
Additional paid-in capital	1,724	2,223
Retained earnings	7,278	5,915
Accumulated other comprehensive loss	(1,553)	(1,532)
Other	(14)	(23)
Total stockholders' equity	7,867	7,021
Total liabilities and stockholders' equity	$ 27,624	$ 25,574

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	(784)	(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	(719)	(708)	(1,461)
Financing Activities
repayment of long-term debt	(53)	(1,069)	(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	(1,431)	(2,146)	(2,076)
Net increase (decrease) in cash and cash equivalents	1,044	70	(1,728)
Cash and cash equivalents at beginning of year	1,080	1,010	2,738
Cash and cash equivalents at end of year	$ 2,124	$ 1,080	$ 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

Answer 1

z-score formula = 1.2A + 1.4B + 3.3C + 0.6D + 0.99E

where, A = working capital / total assets

B = retained earnings / total assets

C = EBIT / total assets

D = market value of equity / book value of liabilities

E = sales / total assest

	In millions
	2005	2004
Total assets	$27,624	$25,574
Current assets	$10,409	$8,973
current liabilities	$9,428	$8,566
retained earnings	$7,278	$5,915
EBIT	$2,956	$2,089
Number of shares	434.26	440.44
Share price	$63.63	$55.55
total liabilities	$19,757	$18,553
sales	$37,213	$35,526
Working capital	$981	$407
Market value of equity	$27,632	$24,466
A	0.036	0.016
B	0.263	0.231
C	0.107	0.082
D	1.399	1.319
E	1.347	1.389

2005 z-score =  1.2*0.036 + 1.4*0.263 + 3.3*0.107 + 0.6*1.399 + 0.99*1.347

= 2.94

2004 z- score = 1.2*0.016 + 1.4*0.231 + 3.3*0.082 + 0.6*1.319 + 0.99*1.389

= 2.77

The company is in grey zone in both the years as the z score is less than 2.9 and more than 1.23. This means it is a reg flag for the company for the potential problems it might face in the near future. The z score has imprived in 2005 on account of all the components of the z score.