Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.36, X₂ = Retained earnings/Total assets = 0.08, X₃ = Earnings before interest and taxes/Total assets = 0.25, X₄ = Market value of equity/Book value of long-term debt = 0.80, X₅ = Sales/Total assets ratio = 0.75. Calculate and interpret the Altman's Z-score for this firm. A) 2.24; High risk B) 2.24; Indeterminate C) 2.60; Low risk D) 2.60; Indeterminate

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Quizplus · Accepted Answer

The Altman's Z-score is calculated using the formula: Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5. Substituting the given values, Z = 1.2(0.36) + 1.4(0.08) + 3.3(0.25) + 0.6(0.80) + 1.0(0.75) = 2.60. A Z-score between 1.81 and 2.99 is considered indeterminate, indicating uncertainty about the firm's financial health.

Suppose That the Financial Ratios of a Potential Borrowing Firm