Question

In: Finance

You are a lending officer working with a financial institution in Dubai. The CFO of a...

You are a lending officer working with a financial institution in Dubai. The CFO of a company, which manufactures custom car parts in Jebel Ali Industrial area, submits to you a loan application. The company, which started as a local car shop in Sharjah, has evolved into a regional product provider. The company is rated CCC and its bonds are trading at 9 per cent (the comparable government bond rate is equal to 4%). These rates are for a 1-year period.  Your bank’s experience is that the recovery rate in the event of default is 50 per cent.

The condensed financial accounts are as follows:

$M

Total current assets

77.1

Total noncurrent assets

744.9

Total assets

1002

Total current liabilities

202.1

Total noncurrent liabilities

288.9

Total liabilities

512.0

Shareholder’s equity

611.0

Retained earnings

99.0

Total Equity

710.0

                                                

The Earnings before interest and tax are equal to AED 212,008,000 on sales of AED 818,111,000. The number of shares on issue is equal to 555,000 shares the share price being AED 1.07. The firm is requesting a loan of AED 90,000,000 to finance its working capital.

Questions:

D-Using Altman Z score, what is the indication of credit risk?

E-Having carried out the Altman Z score analysis, what would be your final decision related to the loan application. Justify your decision.

G-What other information from the text could confirm your decision?

Solutions

Expert Solution

D]

Altman Z-score = (1.2 * working capital to total assets) + (1.4 * retained earnings to total assets) + (3.3 * EBIT to total assets) + (0.6 * market value of equity to total liabilities) + (1.0 * sales to total assets)

working capital = total current assets - total current liabilities = 77,100,000 - 202,100,000 = -125,000,000

market value of equity = shares outstanding * share price = 555,000 * 1.07 = 593,850

Altman Z-score = (1.2 * working capital to total assets) + (1.4 * retained earnings to total assets) + (3.3 * EBIT to total assets) + (0.6 * market value of equity to total liabilities) + (1.0 * sales to total assets)

Altman Z-score = (1.2 * (-125,000,000 / 1,002,000,000)) + (1.4 * 99,000,000 / 1,002,000,000) + (3.3 * 212,008,000 / 1,002,000,000) + (0.6 * 593,850 / 512,000,000) + (1.0 * 818,111,000 / 1,002,000,000)

Altman Z-score = 1.5

A Z-score that is lower than 1.8 means that the company is in financial distress and with a high probability of going bankrupt.

The credit risk is high.

E]

The loan would be rejected because the company has high credit risk due to a high probability of going bankrupt within 1 year.

F]

The company's debt has a low credit rating of CCC


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