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Z-Score - 849 Part III Risk Appendix 30A Predicting...

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Predicting Corporate Bankruptcy: The Z-Score Model 1 Many potential lenders use credit scoring models to assess the creditworthiness of prospec- tive borrowers. The general idea is to find factors that enable the lenders to discriminate be- tween good and bad credit risks. To put it more precisely, lenders want to identify attributes of the borrower that can be used to predict default or bankruptcy. Edward Altman has developed a model using financial statement ratios and multiple discriminant analyses to predict bankruptcy for publicly traded manufacturing firms. The resultant model is of the form Z 3.3 EBIT __________ Total assets 1.2 New working capital _________________ Total assets 1.0 Sales __________ Total assets .6 Market value of equity ___________________ Book value of debt 1.4 Accumulated retained earnings __________________________ Total assets where Z is an index of bankruptcy. A score of Z less than 2.675 indicates that a firm has a 95 percent chance of becoming bankrupt within one year. However, Altman’s results show that in practice scores between 1.81 and 2.99 should be thought of as a gray area. In actual use, bankruptcy would be pre-
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