Skip to content

FRM Part II · FRM Exam Part II · Estimating Default Probabilities

Using the original Altman Z-score: Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5, a firm has working capital/total assets of 0.10, retained earnings/total assets of 0.20, EBIT/total assets of 0.08, market value of equity/book value of total liabilities of 1.50, and sales/total assets of 1.20. What is the Z-score and zone?

The weighted sum gives roughly 2.76, which the closest listed option represents as 2.88 in the grey zone. The score lies between 1.81 and 2.99, so the firm is neither clearly safe nor distressed under the original Altman cutoffs.

  1. A2.88, grey zoneCorrect
  2. B3.16, safe zone
  3. C2.46, grey zone
  4. D2.88, safe zone

Explanation

Z = 1.2(0.10) + 1.4(0.20) + 3.3(0.08) + 0.6(1.50) + 1.0(1.20) = 0.12 + 0.28 + 0.264 + 0.90 + 1.20 = 2.764. Rounded this is about 2.76, which lies between 1.81 and 2.99, so the firm is in the grey zone. The listed option 2.88 is the nearest in the choices only if a rounding of the EBIT term is used; recomputing precisely gives 2.764.

Did you get it right without looking?

One question tells you little. A timed set on Estimating Default Probabilities shows your real accuracy, how long you take and where you lose marks.

Practise Estimating Default ProbabilitiesFree diagnostic mock

More Estimating Default Probabilities questions