Case 1: Bankruptcy Prediction
The Z-score bankruptcy prediction model uses balance sheet and income information to arrive at aZ-Score, which can be used to predict financial distress:
Z= Working capitalTotal Assets×1.2+Retained earningsTotal Assets×1.4+EBITTotal Assets×3.3+SalesTotal Assets×0.99+MV equityTotal liabilities×0.6
EBIT is earnings before interest and taxes. MV Equity is the market value of common equity, which can be determined by multiplying stock price by shares outstanding.
Following extensive testing, it has been shown that companies with Z-scores above 3.0 are unlikely tofail; those with Z-scores below 1.81 are very likely to fail. While the original model was developed for publicly held manufacturing companies, the model has been modified to apply to companies in various industries, emerging companies, and ...view middle of the document...
The various components required for calculating the Z-score are then inserted in the Microsoft Excel sheet and the Z-score is computed according to the formula provided in the case. The components along with the Z-score for the two years are shown in the following table:
| Fu-Wang Foods (2012) | Fu-Wang Foods (2011) | British American Tobacco (2012) | British American Tobacco (2011) |
Current Assets | 474,731,242 | 471,814,728 | 9,172,866 | 7,774,415 |
Current Liabilities | 260,109,346 | 245,131,079 | 7,029,777 | 6,300,705 |
Working Capital | 214621896 | 226683649 | 2,143,089 | 1,473,710 |
Retained Earnings | 105,398,985 | 61,966,056 | 6,368,044 | 5,246,404 |
EBIT | 103,701,847 | 104,820,171 | 6,501,462 | 4,913,656 |
Sales | 758,459,050 | 709,168,568 | 90,174,080 | 75,357,351 |
Stock Price | 24.4 | 28.4 | 1,709.9 | 902.9 |
Shares outstanding | 53,433,600 | 41,104,833 | 60,000,000 | 60,000,000 |
MV Equity | 1303779840 | 1167377257 | 102,594,000,000 | 54,174,000,000 |
Total Assets | 999,896,891 | 909,734,784 | 15,034,493 | 13,151,049 |
Total Liabilities | 260,109,346 | 245,131,079 | 8,001,553 | 7,239,749 |
| | | | |
Z-score | 4.51 | 4.40 | 7701.2 | 4497.3 |
We can see that both the companies have Z-scores which are above 3.0 which mean they are unlikely to fail. The Z-score of Fu-Wang Foods was 4.40 in 2011 and 4.51 in 2012 (increase of 0.11), which means the likeliness of Fu-Wang Foods of getting in financial distress has decreased and its financial condition has improved. Same goes for British American Tobacco (BAT), but in case of BAT, the increase is of 3203.9. The Z-scores of the two consecutive years was already, way above 3.0 and hence BAT is financially in a good position.
According to Z-score bankruptcy prediction model, both Fu-Wang Foods and British American Tobacco are financially unlikely to fail, but British American Tobacco is certainly not going to be in financial distress, theoretically.