Question

2. La Wu manufacturers in Kumerica produce car engines. They have been in the business for almost 20 years.They have been profitable enough to employ more staff and increase their production. But with a recent loan taken to facilitate automation, investors want to know how the company is doing.Their total assets are worth GHS 3,500,000 while they have a working capital of GHS4,200,000. Their liabilities stand at GHS5,000,000 while retained earnings amount to GHS800,000. Earnings Before Interest and Tax come to GHS6,500,000. Sales total GHS8,300,000 while the market value of equity is GHS7,000,000. Using the

Altman Z Score = (1.2 x A) + (1.4 x B) + (3.3 x C) + (0.6 x D) + (0.999 x E)

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

Required :

Determine and explain the results of the Altman’s Z-Score.

Answer 1

Altman Z score= (1.2 * A ) + (1.4 * B ) + (3.3 * C ) + ( 0.6 * D ) + ( 0.999 * E )

A = GHS 4200000 / GHS 3500000 = 1.2

B = GHS 800000 / GHS 3500000 = 0.2286

C = GHS 6500000 / GHS 3500000 = 1.857

D = GHS 7000000 / GHS 3500000 = 1.4

E = GHS 8300000 / GHS 3500000 = 2.37

Altman's Z score = (1.2 * 1.2 ) + (1.4 * 0.229 ) + (3.3 * 1.857 ) + (0.6 * 1.4 ) + (0.999 * 2.37 )

Altman's Z score = 11.096

Altman's Z score is used to predict the probability that a firm will go into bankruptcy within 2 years.

The lower the score , the higher the odds are that a company is heading for bankruptcy. A Z score of lower than 1.8 indicates that the company is on its way to bankruptcy. Company with score above 3 areunlikely to enter bankruptcy. Scores between 1.8 and 3 define a gray area.

In the given case the Altman's Z score is 11.096 , which means the company's financial position is good.