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Altman Z-Score Analysis – Are they going to bankrupt?

Altman Z-Score is a predictive model created by Edward Altman in the 1960s. This model combines five different financial ratios, each assigned a different weight, to determine the likelihood of bankruptcy amongst companies.  The Z-score formula has three different weighted value type below:

1) Publicly Held Firm

Financial Ratios

T1 = Working Capital / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Market Value of Equity / Total Liabilities

T5 = Sales/ Total Assets

Z score bankruptcy model:

Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5

Zones of Discrimination:

Z > 2.99 -“Safe” Zones

1.81 < Z < 2.99 -“Grey” Zones

Z < 1.81 -“Distress” Zones

2) Privately Held Firm

Financial Ratios

T1 = (Current Assets − Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

T5 = Sales/ Total Assets

Z’ Score Bankruptcy Model:

Z’ = 0.717T1 + 0.847T2 + 3.107T3 + 0.420T4 + 0.998T5

Zones of Discrimination:

Z’ > 2.9 -“Safe” Zone

1.23 < Z’ < 2.9 -“Grey” Zone

Z’ < 1.23 -“Distress” Zone

3) Public OR Private Non-Manufacturing

Financial Ratios

T1 = (Current Assets − Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

Z-Score bankruptcy model:

Z = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4

Zones of discrimination:

Z > 2.6 -“Safe” Zone

1.1 < Z < 2.6 -“Grey” Zone

Z < 1.1 -“Distress” Zone

 

We choose the second type (private firms) to estimate the three airlines companies and got the following result:

  Southwest Airlines Co. American Airlines Inc. Delta Air Lines Inc.

12/31/2010

2.9787

-1.2781

-0.9620

12/31/2009

2.5266

-1.3079

-1.0310

12/31/2008

2.0062

-1.7859

-2.0923

 

From the chart, we can see only Sothwest Airlines Co. has the health and steady growth in its Z-Score shape. The other companies are way down below zero value due to their operation loss in 2008 to 2010 fiscal years. Through the Z-Score analysis, robust financial structure can be proven to be the strength of Southwest Airlines Co.

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