Suppose that the financial rat

Suppose that the financial ratios of a potential borrowing firm take the following values:

X1   =  0.2

X2   =  0

X3  =   – 0.20

X4   =  0.10

X5   =  2.0  

The ratio X2 is zero and X3 is negative, indicating that the firm has had negative earnings or losses in recent periods. Also, X4 indicates that the borrower is highly leveraged. However, the working capital ratio ( X1) and the sales/assets ratio ( X5) indicate that the firm is reasonably liquid and is maintaining its sales volume. The Z score provides an overall score or indicator of the borrower’s credit risk since it combines and weights these five factors according to their past importance in explaining borrower default. For the borrower in question:

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