In Question 1, we discussed Altman Z that measures a firm's creditworthiness:

AltmanZ=1.2WC/TA+1.4RE/TA+3.3EBIT/TA+1.0Sales/TA+0.6MVE/BVLTD

An index that measures ability to obtain external financing is the KZ Index. The KZ-Index (Kaplan-Zingales Index) is a relative measurement of reliance on external financing. Companies with a higher KZ-Index scores are more likely to experience difficulties when financial conditions tighten since they may have difficulty financing their ongoing operations.

The KZ-Index (Kaplan-Zingales Index) is described in Lamont, Polk and Saa-Requejo (2001):

KZ_Index=-1.002(Cash Flows)/K+0.283Q+3.139Debt/(Total Capital)-39.368Dividends/K-1.315Cash/K

Where:

Cash Flows = (Income Before Extraordinary Items_t + Total Depreciation and Amortization_t), K = Property, Plant and Equipment_t-1, Q = (Market Capitalization_t + Total Shareholder's Equity_t - Book Value of Common Equity_t - Deferred Tax Assets_t) / Total Shareholder's Equity_t, Debt = Total Long Term Debt_t + Notes Payable_t + Current Portion of Long Term Debt_t ,Dividends = Total Cash Dividends Paid_t (common and preferred) and Cash = Cash and Short-Term Investments_t. The ratio has been slightly modified by reducing the number of decimal places.

Your bank manager has asked you if it is possible to combine Altman Z and KZ index to permit improved decisions on whether a firm should have their loans approved (or rejected). You have created the figure below.

High Altman Z & Low Kaplan-Zingales KZ High Altman Z & High Kaplan-Zingales KZ

Quadrant 2 Quadrant 1

Low Altman Z & Low Kaplan-Zingales KZ Low Altman Z & High Kaplan-Zingales KZ

Quadrant 3 Quadrant 4

Given the four quadrants (Quadrants 1 to Quadrant 4) develop justifications for either approving or rejecting a loan from each quadrant.

Please ensure that you use the spaces provided in the next page for your answer.

Quadrant 1:

Quadrant 2:

Quadrant 3:

Quadrant 4: