The Z-score bankruptcy model uses balance sheet and incomeinformation to arrive at a Z-Score, which can be used to predictfinancial distress. The Model follows:
Z= ((Working capital / Total assets) x 1.2) + ((Retainedearnings /Total assets ) x 1.4) + ((EBIT / Total Assets) x 3.3) +((Sales / Total assets ) x 0.99) + ((MV Equity / total liabilities)x 0.6)
EBIT is Earnings before Interest and Taxes.
MB Equity is the market value of common equity, which can bedetermined by multiplying stock price by shares outstanding.
Following extensive testing, it has been shown that companieswith Z-scores above 3.0 are unlikely to fail; those with Z-scoresbelow 1.81 are very likely to fail. While the original model wasdeveloped for publicly held manufacturing companies, the model hasbeen modified to apply to companies in various industries, emergingcompanies, and companies not traded in public markets.
For this discussion choose two publicly traded companies thatyou can find the financial statements for - one obviouslyprofitable and the other either closed or going through bankruptcy( Sears, KMart, etc). Compute the z-scores for the two latest yearsprovided and interpret the results. Where do the company's fall inthe financial distress range? Share the companies you chose, theZ-scores for each, and how this information helps you understandthe companies. Can you use this model to analyze your own companyor others you may be interested in?
