TUTORIAL 4

1. Using the financial information below, determine the company’s stress position in

terms of corporate failure. Additional information includes that the average share price

for the period was RM1.40.

x1 = Working Capital (Current Assets – Current Liabilities) / Total Assets

= (1,182,000 – 736,000) / 2,882,000

= 0.1548

x2 = Retained Earnings / Total Assets

= 1,154,000 / 2,882,000

= 0.4004

x3 = Earnings before Interest and Taxes / Total Assets

= 245,000 / 2,882,000
 = 0.0850

x4 = Market Value Equity / Total Liabilities

= (100,000 x RM1.40) / 1,619,000

= 0.0865

x5 = Sales / Total Assets

= 3,393,000 / 2,882,000

= 1.1773

Z – score = (1.2* x 1 + 1.4* x 2 + 3.3* x 3 + 0.6* x 4 + 0.999* x 5)

Z – score = (1.2 x 0.1548 + 1.4 x 0.4004 + 3.3 x 0.0850 + 0.6 x 0.0865 + 0.999 x 1.1773)

= 0.18576 + 0.56056 + 0.2805 + 0.0519 + 1.17612

= 2.25484

How many percent of risk does the company take?

{(3.0 – 2.25484) / (3 – 1.8)} x 100% = 62.1%

How to improve?

Firstly, improve sales will create the x5 to increase and then z-score will also increase. By
improving the sales, the company can expand to new market/more market/introduce more
product. After improved the sales, the earnings before taxes and interest will also be
improved and then caused to the x3 to increase and hence the z-score will also increase. Next,
retained earnings improved will increase the x2 and z-score too. Furthermore, improve
market equity will create the x4 to increase and the z-score will also increase. Lastly, improve
working capital will increase the x1 and hence the z-score will also increase.
2. Define financial risk, credit risk and currency risk.

Financial risk is caused due to market movements and market movements can include a host
of factors. Based on this, financial risk can be classified into various types such as credit risk,
liquidity risk, exchange rates risk, foreign exchange risk and interest rate risk. Financial risk
is the uncertainty arising due to the use of debt finance in the capital structure of the
company. Financial risk is the inability of the firm to pay off the debt it has taken from the
bank or the financial institution.

Credit risk, also known as default risk, which arises from the inability of one party to pay or
fulfill its obligations to another, such that they will be in default. If a company is unable to
collect its receivables from customers, they will have poor cash inflow and lost income.

Currency risk, also known as foreign exchange risk, which arises from movements in foreign
markets. Foreign exchange rates of currencies will definitely have an impact on the earnings
of a business with foreign operations or conduct foreign transactions. For example, if a
foreign buyer’s currency depreciates, you receive less payment amount in your currency.

3. Discuss methods to implement financial risk management.

Firstly, develop good financial discipline and internal control. For example, separation of
duties, this internal control activity divides responsibilities among multiple employees to
minimize the risk of errors or inappropriate actions.

Next, develop concise reporting tools. For instance, integrated reporting provides a single,
clear and concise report that is easy to access. Integrated reporting can better identified the
risk and opportunities because it brings together material information about an organization’s
strategy, governance, performance and prospects in a way that reflects the commercial, social
and environmental context which it operates.

The third method is to prepare cash budget. The cash budget is the combined budget of all
inflows and outflows of cash. It should be divided into the shortest time possible, so
management can be quickly made aware of potential problems resulting from fluctuations in
cash flow. The budget helps estimate the source, amount, and timing of cash collection and
cash payments as well as determine if and when additional financing is needed, or debt can
be paid.

Moreover, purchase credit insurance to cover non repayment of trade receivables. Credit
insurance covers the business against any losses caused by the inability to collect payment
from a customer for a variety of reasons.

The last method is to monitor the change of interest rate, inflation rate and foreign currency
exchange rate. For instance, carefully monitor interest rates and make decisions based on how
interest rates are perceived to change over time. To monitor the change of inflation rate, it is
possible to look at the overall economy or a specific sector. Overall price change in the
economy is tracked by the GDP (Gross Domestic Product) Deflator and more concentrated
price changes are tracked by the CPI (Consumer Price Index). Many methods of forecasting
currency exchange rates which are purchasing power parity, relative economic strength, and
econometric models.
4. Discuss any three qualitative factors that predict corporate failures.

Poor in management quality

Poor quality can lead to many different consequences including lost revenue, decreased
customer loyalty, increased costs, and legal actions.

Insufficient insurance coverage

Under or insufficient insurance means that the corporate doesn't have the correct insurance in
place, leaving the company or the business exposed to potentially large financial losses.

Inability to obtain financing

A situation where the corporate lack adequate access to capital at reasonable rates in order to
either finance their core business activities or expand their business, this represents a real
hindrance to market growth. 

Failure to keep up to date

Maintaining accurate and up-to-date minute books and corporate records avoids problems,
costs, aggravation and embarrassment. 

Cash flow issue

A cash flow problem occurs when the amount of money flowing out of the company
outweighs the cash coming in. This causes a lack of liquidity, which can inhibit your ability
to make payments to suppliers, repay loans, pay your bills and run the business effectively.
5. Discuss how risk impact on the market value of a firm?

Management of risk is an integral part of good practice and quality management. Learning
how to manage risk effectively enables managers to improve outcomes by identifying and
analysing the range of issues and providing a systematic way to make informed decisions. So,
the primary objective of a business is to maximize wealth of its shareholders.

Risk has a significant impact on the market value of a firm, as investors assess and adjust
their expectations of the firm's future earnings and cash flows based on the perceived level of
risk. In general, higher risk is associated with lower market value, while lower risk is
associated with higher market value. Hence, firms with higher financial risks would have a
lower market value.

Different types of risks can impact the market value of a firm in different ways. Here are a
few examples:

1. Liquidity risk: Liquidity risk is the risk that a firm may not be able to meet its
financial obligations as they come due. This can happen if the firm's assets cannot be
easily converted into cash, or if the firm has a sudden need for cash that it cannot
meet. In such cases, investors may perceive the firm to be riskier and demand a higher
return on investment, which can lower the firm's market value.

2. Credit risk: Credit risk is the risk that a borrower may not be able to repay its debt
obligations. This risk can impact a firm's market value in several ways. First, if
investors perceive the firm's credit risk to be high, they may require a higher rate of
return to compensate for this risk, which can lower the firm's market value. Second, if
the firm defaults on its debt obligations, it may face legal or financial penalties, which
can further erode its market value.

3. Interest rate risk: Interest rate risk is the risk that changes in interest rates will impact
a firm's financial performance. For example, if a firm has a lot of debt with variable
interest rates, a rise in interest rates can increase the firm's debt service costs, which
can lower its profitability and market value. Conversely, if interest rates fall, the firm's
debt service costs may decrease, which can increase its profitability and market value.

4. Inflation risk: Inflation risk is the risk that inflation will erode the purchasing power
of a firm's cash flows. This can impact the market value of a firm in several ways.
 First, if investors perceive that a firm's cash flows will be eroded by inflation, they
may require a higher rate of return to compensate for this risk, which can lower the
firm's market value. Second, if the firm is unable to pass on the cost of inflation to its
customers, its profitability may be lower, which can also lower its market value.

5. Currency risk: Currency risk is the risk that changes in exchange rates will impact a
firm's financial performance. For example, if a firm earns a significant portion of its
revenue in a foreign currency, a sudden devaluation of that currency can decrease the
firm's profitability and market value. Conversely, if the firm's home currency
strengthens against foreign currencies, its profitability may increase, which can
increase its market value.

In summary, different types of risk can impact the market value of a firm in different ways.
Investors assess a firm's risk level when making investment decisions, and firms that are
perceived as higher risk are generally valued lower than those with lower risk levels. To
mitigate the impact of risk on their market value, firms can implement effective risk
management strategies