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Self Test Exercise

A financial services provider approaches for a $150 million loan to fund acquisitions. While the company has strong financial performance and experienced management, its high debt levels and acquisition-focused growth strategy increase financial risk. A credit analysis finds the company has a moderate credit rating but low liquidity ratios, and its Altman Z-score of 1.3348 indicates it is in the 'grey area' of bankruptcy risk.

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28 views

Self Test Exercise

A financial services provider approaches for a $150 million loan to fund acquisitions. While the company has strong financial performance and experienced management, its high debt levels and acquisition-focused growth strategy increase financial risk. A credit analysis finds the company has a moderate credit rating but low liquidity ratios, and its Altman Z-score of 1.3348 indicates it is in the 'grey area' of bankruptcy risk.

Uploaded by

trangvnngn0308
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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The remaining questions are based on the following proposal.

A financial services provider that provides computer software systems


approaches you. The company started off as a small private company and
has grown strongly over the past fifteen years and listed on the Australian
Stock Exchange. The company has businesses in many off-shore locations,
all of which are well-developed capital markets. In some parts of the
world, the company has near-monopoly markets.
As part of its strategy, the company uses acquisitions rather than growth
to continue to expand the business. While the business is software based,
it relies on continued activity in the financial markets.
The company has had the same management over the past fifteen years
and the senior management team are shareholders in the company.
The company is rated BBB and its bonds are trading at 3.3 percent above
the comparable government bond rate, with the share price being $5.60.
Your bank’s experience is that the recovery rate in the event of default is
50 percent.

Earnings before interest and tax are $151 608 000 on sales of $742 613 000.
The firm is requesting a loan of $150 million to assist further acquisitions.
1. Carry out a credit analysis on an expert basis.
2. Carry out a credit analysis on a market-premium basis.
3. Assuming the following function, make an assessment of the credit risk:
4. Using the Altman Z score, what is the indication of credit risk?
5. Having carried out the above analysis, carefully outline the benefits and
disadvantages of lending to this company. What would be your final
decision?
1. A credit analysis on expert basis
5C approach
Character : There is one issue with this company in terms of its
character and that is its listing on the Australian Stock Exchange. If
the company has been diligent in submitting its reports, there
should be no doubts on its character. However, it is important to
note that the use of the funds is not particularly well defined. While
the company has used acquisitions to grow, there is no data on the
use of these funds. This should be questioned.
Capacity: There is no indication that the company is bankrupt so
there does not appear to be any reason that the company cannot
borrow.
Cash: The normal way to view this component is by doing some
financial statement analysis. However, the accounts as presented do
not balance. This is a mistake and is needed to highlight that care
must be taken to examine the accounts independently. Incorrect or
sloppy accounts could reveal the way the company operates.
Some ratio are as follows.
Liquidity:
Current ratio = Current Assets/ Current Liabilities = 66.3/197.3 =
0.34
This is below the normal benchmark. It could indicate a difficulty in
paying accounts as they come.

Note that there is no inventory number in the accounts as provided.


If we make an assumption that all the current assets are inventory
we would get, the activity ratio is as follow:
Inventory Turnover = Net sales/Inventory = 742.6/66.3 =11.20
times
While this result appears good being above the rough benchmark of
4 times, it would need to be balanced off against industry average.

A profitability ratio as follows:


Net profit to sales = Net profit/Net sales = 151.6/742.6 = 0.2041 or
20.41%
This appears to be very satisfactory.
Solvency ratio:
Debt to equity = Debt/Equity = 473.0/3066.6= 0.15 or 15%
(Note: the equity number is the number of shares time the share
price. There will be some dispute on whether the book value or
market value is taken. Assume that we use the market value). This is
below the benchmark of 2 and interestingly below the industry
benchmark as well.
Collateral: No collateral has been offered. If the loan is considered
to be risky, then collateral should be sought. However, the main
asset of the company is software and this could be difficult to value.
Conditions: This is the most difficult to assess. The company's
earnings are highly dependant on the state of the financial markets.
If there is a bear markets the earnings available to make repayments
would be reduced. Therefore, there is some susceptibility to the
general economy.
Control: Experienced management team with ownership suggests
good control. However, there is no information relating to law and
regulation relating to making loans or accounting standard
5. Benefits and disadvantages of lending to this company.
Benefits:
Benefits:
- strong financial performance: Impressive high EBIT indicates a
healthy operating margin and profitability
- Diversified Operations: With businesses in multiple locations,
including near-monopoly markets in some regions, the company
demonstrates geographic diversification, reducing the risk
associated with dependence on a single market.
- Experienced Management: The fact that the company has had the
same management team for fifteen years, with high-qualified and
experienced staffs and board members
- Favorable Credit Rating: The company is rated BBB, indicating
moderate credit risk, suggesting a level of investor confidence in the
company's financial stability.
Disadvantages:

- Acquisition Strategy: While using acquisitions for growth can be


advantageous, it also comes with risks that can affect business plan
of this company
- High Debt Levels: debt to equity ratio of approximately 0.15. High
debt levels increase financial risk and could affect the company's
ability to meet its debt obligations.

4. Z-score:
a. WC/Total assets = (66.3-197.3)/904 = -0.145
b. Accumulated retained earnings / Total assets = 84/904=0.093
c. Operating profit / Total assets = 151,608,000/904,000,000 = 0.168
d. MV of shares / BV of liabilities =
(5.6*547,612)/(197,300,000+243,700,000) = 0.007
e. Sales Revenue / Total assets = 742.613/904 = 0.82

z-score = -0.145*1.2 + 1.4*(0.093) + 3.3*(0.168) + 0.6*(0.007) + 1*(0.82) =


1.3348
Because z-score = 1.3348 < 1.81, the co

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