Question

MNO, Inc., a publicly traded manufacturing firm in the United States, has provided the following financial information in its application for a loan. The market value of equity is 1.58 times the book value of debt. Retained earnings are 5.27% of total assets. Sales are 52% of total assets. Earnings before interest and taxes are 32.87% of total assets. Finally, Working capital is 34.25% of total assets.

a) What is the Altman discriminant function value for MNO, Inc.?

b) Should you approve MNO, Inc.'s application to your bank for a $5,000,000 capital expansion loan?

c) If sales for MNO were 38% of total assets and the market value of equity was only half of book value, would your credit decision change?

Answer 1

a)
Altman’s discriminant function is given by
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
X1 = Working capital/total assets (TA) =	34.25%
X2 = Retained earnings/TA =	5.27%
X3 = EBIT/TA =	32.87%
X4 = Market value of equity/long term debt =	1.58
X5 = Sales/TA =	52%
Z = 1.2 x 34.25%+ 1.4 x 5.27% + 3.3 X  32.87% + 0.6 x 1.58 + 1.0 x 52%	3.03749
b)
Since the Z-score of 3.03749 which is greater than 2.99, MNO Inc.’s application for a capital expansion loan should be approved
c)
Altman’s discriminant function is given by
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
X1 = Working capital/total assets (TA) =	34.25%
X2 = Retained earnings/TA =	5.27%
X3 = EBIT/TA =	32.87%
X4 = Market value of equity/long term debt =	0.50
X5 = Sales/TA =	38%
Z = 1.2 x 34.25%+ 1.4 x 5.27% + 3.3 X  32.87% + 0.6 x .50+ 1.0 x 38%	2.24949
Yes Credit decision will  change  Since the Z-score of 2.24949  which is smaller  than 2.99