George Stamper a credit analyst with Micro-Encapsulators Corp. (MEC) needs to respond to an urgent email request from the southeast sales office. The local sales manager reported that she had an opportunity to clinch an order from Miami Spice (MS) for 50 encapulators at $10,000 each She added that she was particularly keen to secure this order since MS was likely to have a continuing need for 50 encapulators a year and could therefore prove a very valuable customer. However, orders of this size to a new customer generally required head office agreement, and it was therefore George's responsibility to make a rapid assessment of MS's creditworthiness and to approve or disapprove the sale.

Mr. Stamper knew that MS was a medium-sized company with a patchy earnings record. After growing rapidly in the 1980s, MS had encountered strong competition in its principal markets and earnings had fallen sharply. Mr. Stamper was not sure exactly to what extent this was a bad omen. New management had been brought in to cut costs, and there were some indicators that the worst was over for the company. Investors appeared to agree with this assessment, for the stock price had risen to $5.80 from its low of $4.25 the previous year. Mr. Stamper had in from of him MS's latest financial statements, which are summarized in table 20.4. He rapidly calculated a few key financial ratio's and the companies Z score. Mr. Stamper also made a number of other checks on MS. The company had a small issue of bonds outstanding, which were rated B by Moody's. Inquiries through MEC's bank indicated that MS had unused lines of credit totaling $5 million but had entered into discussions with its bank for a renewal of a $15 million bank loan that was due to be repaid at the end of the year. Telephone calls to MS's other suppliers suggested that the company had recently been 30 day's late in paying its bills.

Mr. Stamper also needed to take into account the profit that the company could make on MS's order. Encapulators were sold on standard terms of 2/30, net 60. So if MS paid promptly, MEC would receive additional revenues of 50 X $9,800 =$490,000. However, given MS;s cash position, it was more than likely that it would forgo the cash discount and would not pay until sometime after the 60 days. Since interest rates were about 8%, any such delays in payment could reduce the present value to MEC of the revenues. Mr. Stamper also recognized that there were production and transportation costs in filling MS's order. These worked out at $450,000 or $9,500 a unit. Corporate profits were taxed at 35%.

What is the break-even probablity of default? How is it affected by the delay before MS pays its bills?

Formula in text for break-even probability of default is (1-p) = 1 - PV(COST)/PV(REV) = PV(PROFIT)/PV(REV)

Part Six Financ 20.4 Miami Summary financial state analyst with Micro lators Corp. (figures millions dollars) 2012 of in to an urgent e-mail from the request that she local sales manager reporte MS) for ets nch an order from Miami Spice assets each. She added that she was con- Current marketable securities 5.0 s order since MS was kely have a and receivable 16.2 fore pro Cash a year and could there Accounts 27.5 However, orders of this size to a was nventories ined head office agreement, and it o assets 48.7 bility to make a rapid assessment Total current approve or disapprove the sale assets ha at MS was a medium-sized company wi Fixed equipment 228.5 After growing rapidly in the 1 MS had Property, plant, and 129.5 tion in its principal markets and cam accumulated depreciation 99.0 what Less Mr. Stamper not sure exactly in assets New management had been brought Net fixed 147.7 some indications that the worst was over assets Equity appeared to agree with this assessment, Total Shareholders' to from its low of S425 the Liabilities and front of him MS's latest financ Current liabilities 22.8 ized in Table 20.4. He rapidly calcu repayment ratios and the sz score. Debt due for 19.0 company Accounts payable ber of other checks on rat liabilities 41.8 of bonds outstanding, which were Total current llrough MEC's bank indicated that MS 40.8 totaling $5 million but had entered into Long-term debt for a renew al of a $15 million bank ioan Shareholders' equity at the end of the year Telephone calls to stock' 10.0 that the company had recently been Common earnings 55.1 Retained 32.5 60 127.6 100.5 28.0 42,3 10.0 Total shareholders' equity 65.1 d to take into account the profit that the 74.4 MS's order. Encapsulators were sold on Total liabilities and shareholders' equity 1477 160.9 60. So if MS paid promptly, MEC evenues of 50 x $9,800 S490,000. ncome Statement position, it was more than likely that it 149.8 134.4 Revenue unt and would not pay until sometime 131.0 124.2 cost of goods sold terest rates were about 8%, any such duce the present value to MEC of the 1.7 Other expenses recognized that there were production 8.1 8.6 Depreciation lling MS's order. These worked out at Earnings before interest and taxes 7.1 Corporate profits were taxed at 35% 5.1 5.6 interest expense 4.4 ncome taxes Miami Spice's creditworthiness? Net income bability of default? How is it affected Allocation of net income ys its bills? per's decision be affected by the Addition to retained earnings 9.3 1.5 Dividends 0 million shares, value