Competition also arises from specialty stores that

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and lumber yards create additional rivalry (such as Ace Hardware and Sears). Competition also arises from specialty stores that focus on one aspect of home improvement such as flooring, kitch- ens, lighting, and roofing. Home Depot's garden center faces competition from national nurseries, and most cities have large local nurseries and garden specialty shops. Increasingly, Home Depot faces competition from online vendors such as US Appliances, iFloor, and nurseries such as Autumn Ridge and Henry Fields. 4-9 Module 4 I Credit Risk Analysis and Interpretation the loss given a default. While lenders have different information sets and use different credit analysis models, there are four common steps to determine the chance of default. We discuss each of these four steps and we consider how creditors might limit their losses in the event of default. Chance of Default The chance of default depends on the company's ability to repay the debt which, in turn, depends on the company's future performance and cash flow. Different lenders approach credit analysis with different techniques. The following discussion is comprehensive, and not a script r that anyone creditor follows. As a starting point, the analysis considers the company's past performance and its current financial condition, projects future cash flows, and determines a probability that a company will have insufficient cash to repay the loan. Step 1: Assess nature and purpose of the loan A necessary first step for the prospective lender is to determine why the borrower needs the loan. If one cannot be assured of the need for credit, proceeding to the analysis stage is point- less. As we explained, there are many reasons to borrow (for cyclical cash flow needs, to fund temporary or ongoing operating losses, for major capital expenditures or acquisitions, or to reconfigure capital structure). The nature and purpose of the loan affect its riskiness. Lending to a company that needs funds for ongoing operations is riskier than a company that needs funds to expand into a new profitable market segment. In the year ended January 2007, Home Depot borrowed almost $9 billion, using some proceeds to repay maturing debt, fund the repurchase of stock, and to acquire Hughes Supply, Inc. That year, the company also sold commercial paper to support short-term liquidity needs. The nature and purpose of the loan also affect the focus and depth of the lender's credit analysis. For example, trade creditors will not do as in- depth an analysis as a mortgage lender. Each computes and analyzes the same types of ratios but their emphases will differ. Step 2: Assess macroeconomic environment and industry conditions Like financial analysis, credit analysis must consider the broader business context in which a company operates. The nature of the competitive intensity in the industry affects the expected level of profitability. Global economic forces affect the macro economy in which the company operates. Government regulation, borrowing agreements exacted by creditors, and internal governance procedures also affect companies' range of operating activities. Such external
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