Comfort Home Limited (Comfort) is a manufacturer of battery packs. It has expanded rapidly in the last few years under the leadership of its autocratic chairman and chief executive officer, Wong. Wong is relentlessly optimistic. He likes to get his own way and demands absolute loyalty from all his colleagues.

The company has developed a major new product over the last three years which has necessitated a large investment in new equipment. The board has stated that this more efficient battery is critical to the future of the business as the company operates in a sector where customers expect constant innovation from their suppliers.

However, the recent share price performance has caused concern at board level and there has been comment in the financial press about the increased gearing and the strain that this expansion is putting on the company. The average share price has been $1.56 (2017), $2.17 (2018) and $1.64 (2019). There are 450 million shares in issue.

A relevant Z-score model for the industry sector is:

Z = 12X1 + 14X2 + 33X3 + 06X4 + X5

Where

X1 is working capital/total assets (WC/TA);

X2 is retained earnings reserve/total assets (RE/TA);

X3 is Profit before interest and tax/total assets (PBIT/TA);

X4 is market value of equity/total long-term debt (MVE/total long-term debt); and

X5 is Revenue/total assets (Revenue/TA).

Generally, with reference to this industry, a score of more than 3.5 is considered safe and at below 18, the company is at risk of failure in the next one to two years. The companys recent income statements are summarized below:

Summary Income Statements

	2017	2018	2019
	$m	$m	$m
Revenue	1,460	1,560	1,915
Operating costs	1,153	1,279	1,624
Operating profit	307	281	291
Interest	35	74	95
Profit before tax	272	207	196
Tax	87	66	61
Profit for the period	185	141	135

A junior analyst in the company has correctly prepared a spreadsheet calculating the Z-score as follows:

	2017	2018	2019
Share price ($)	1.56	2.17	1.64
No. of shares (millions)	450	450	450
Market value of equity ($m)	702	976.5	738
X1 WC/TA	-0.163	-0.103	-0.087
X2 RE/TA	0.151	0.167	0.167
X3 PBIT/TA	0.227	0.136	0.078
X4 MVE/Total long-term debt	1.510	0.758	0.478
X5 Revenue/TA	1.0775	0.756	0.780
Z Score	2.749	1.770	1.454
Gearing [debt/equity]	107%	133%	152%

You are required to:

1. Comment on the results in the junior analysts spreadsheet. (10 marks)

2. Identify the qualitative problems that are apparent in the companys structure and performance and explain why these are relevant to possible failure.

(Hints: management structure, personality and culture, operational structure, financial indicators, etc.)

3. Critically assess the results of your analysis in parts (a) and (b) alongside details of the companys recent financial performance and suggest additional data that should be acquired and how it could be used to assess the financial health of the company. (10 marks)