Question 1: What is Cineplex’s Altman Z-Score for 2013 and 2014?
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
Where:
X1 = Net Working Capital/Total Assets (it measures liquidity)
X2 = Retained Earnings/Total Assets (it measures the cumulative profitability)
X3 = Earnings before Interest and Tax/Total Assets (it measures the return on assets)
X4 = Equity Market Value/Book Value of Liabilities (it measures the market leverage)
X5 = Total Revenue/Assets (It measures the revenue generating potential of total assets)
X1 = Net Working Capital/Total Assets = -184,021/1,609,416 = -0.11
X2 = Retained Earnings/Total Assets = -123,771 / 1,609,416 = -0.08
X3 = Earnings before Interest and Tax/Total Assets = (97,415 + 21,948) / 1,609,416 = 0.07
X4 = Equity Market Value/Book Value of Liabilities = 3,131,847/877,567 = 3.57
X5 = Total Revenue/Assets = 1,234,716 / 1,609,416 = 0.77
The current share price of Cineplex according to Google Finance is 49.7 Canadian dollars. The outstanding number of shares as at 31st December 2015 was 63,015,023.
Therefore, the current market value equity = 49.7*63,015,023 = 3,131,846,643
Z = 1.2 * -0.11 + 1.4 * -0.08 + 3.3 * 0.07 + 0.6 * 3.57 + 1.0 * 0.77 = 4.009
Figures are expressed in thousands of Canadian dollars.
X1 = Net Working Capital/Total Assets = - 159,991 / 1,591,378 = -0.1
X2 = Retained Earnings/Total Assets = -107,323 / 1,591,378 = -0.07
X3 = Earnings before Interest and Tax/Total Assets = 127,277 / 1,591,378 = 0.08
X4 = Equity Market Value/Book Value of Liabilities = 3,131,847 / 843,106 = 3.71
X5 = Total Revenue/Assets = 1,591,378 /1,591,378 = 0.74
The current share price of Cineplex according to Google Finance is 49.7 Canadian dollars. The outstanding number of shares as at 31st December 2015 was 63,015,023.
Therefore, the current market value equity = 49.7*63,015,023 = 3,131,846,643
Z = 1.2 * -0.1 + 1.4 * -0.07 + 3.3 * 0.08 + 0.6 * 3.71 + 1.0 * 0.74 = 4.64
Question 2: Assume you work for a commercial bank. Would you extend new credit to Cineplex? Why? Why not?
I would not extend new credit to Cineplex. The Altman z-score for Cineplex is above 3.0. Firms with a score of above 3.0 are considered safe and unlikely to insolvent in the foreseeable future. A score of between 2.7 and 3.0 is considered as a grey area while firms with a z-score of between 1.8 and 2.7 are potential candidates for bankruptcy in the next 2 years. Firms with a z-score of below 1.8 are very likely to be bankrupt. The Altman z-score in isolation shows that the firm is unlikely to go bankrupt any soon. However, there is need to evaluate other indicators and compare the performance of the firm over time. Firstly, the Altman Z-score of the company has declined significantly from 4.64 to 4.009. It is an indication that the debt management is worsening, and the probability of bankruptcy is increasing. If the trend continues, the Altman z-score may slide below 2.7 in the following year making Cineplex a likely candidate for bankruptcy. Providing debt financing to Cineplex is a sure way of increasing the likelihood of the Altman Z-score below the critical point. This is because an increase in long-term debt will reduce the measure of market leverage while an increase in short-term debt will reduce the measure of liquidity. Secondly, the company has negative working capital. It is an indication that the company uses an aggressive debt strategy which creates operational and liquidity risks. Thirdly, the company has negative retained earnings. It means that the company has accumulated losses over the years. Therefore, there is no buffer to compete the various stakeholders in case the company ceases operations. Lastly, the company has accumulated more debt in 2014 compared to 2013. The risk of financial distress is positively related with the level of gearing. Therefore, Cineplex has a high risk of financial distress in 2014 compared to 2013. The heightened financial distress risk would make me reluctant to extend credit. It may be necessary to conduct a benchmark analysis to compare the performance of Cineplex to its competitors so as to assess if its debt management is unique to itself or it is an industry practise.
Question 3: As an investor, would you purchase any of Cineplex’s existing debt? Why or why not? Under what conditions would you be willing to purchase?
I will not be willing to purchase Cineplex existing debt. This is because the company is highly geared which raises bankruptcy risk. The company seems to be keen on accumulating debt which is likely to raise the risk of financial distress. Besides, a high gearing ratio will translate into high-interest expenses that will lower profitability significantly. The company has very thin margins. For instance, in 2014, the net profit margin was only 9.6 percent. Raising debt may result in operating losses which may worsen the firm’s situation.
I will be willing to buy existing debt if the firm commits to reducing the debt level instead of accumulating further debt. The company should also adopt an appropriate debt management strategy. The company employs an aggressive debt management strategy which has resulted in negative working capital. The company should also provide a clear strategy on how it intends to turn around the firm and reverse the negative retained earnings. The strategy should include how it will increase revenues, reduce costs and improve profit margins.
Question 4: Using the growth and discount rates (assume the cost of equity is the same as the discount rate) for 2013 given in Note 16 of Cineplex’s 2014 financial statements, what is the market’s assessment of Cineplex’s steady state return on equity at the end of 2014?
Where V = 49.7
B = 1
g = .00
re = .0354
49.7 = ROE – 0.0354/0.0354
ROE = 1.72
The steady growth is 172%
The steady state return to equity is 172%.
The share price is assumed to the current share price as shown by google finance.
The book value is 1 Canadian Dollar.
The return on equity which is assumed to be the cost of equity is given by the dividend yield.
The steady state return to equity could be high because of the situation at the firm. The company is negative retained earnings. The book value is very low compared to the current market price. The cost of equity is also very low which can be attributed to the low net income of the company. Therefore, it cannot afford to pay high dividends. Dividends are normally paid out of net income or retained earnings. However, since the company has negative retained earnings, it can only pay dividends out of its net income.
