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Financial Analysis and Credit Evaluation Case Study

## Interest Rates and Loan Pricing

SBSC bank currently pays 1.55% p.a. on 12-month term deposits and expects to be able to attract similar funds in 12 months’ time at a cost of 1.35%. Accordingly, it has priced a fixed two-year loan of \$5,500,000 at 1.0% over the expected cost of funds with interest paid annually. The day following the issue of the loan, the yield on both one- year and two-year maturity government bonds (indicators of market rates) decreased by 0.20% p.a.

• Ignoring all other assets and liabilities calculate the present value of the expected interest margin.
• What is the importance of the loan-to-value ratio (LVR)? If the LVR is 55% for a loan based on a firm’s accounts receivable, is the credit risk of the lender fully covered?
• ESG Prime Bank has an obligation of \$750 at the end of the first period and \$550 at the end of the second period. It also has \$1,528.93 to invest and can choose between zero-coupon bond or the coupon bond. The coupon bond matures in two years, pays an annual coupon of \$100, and has a balloon payment of \$1,400. The zero-coupon bond has a balloon payment of \$1,610 at the end of the second year. The default-free yield on a one-year bond is 10%, and the annualized yield on a two-year bond is also 10%. What is the present value of the bank’s equity?

(ii) Suppose the interest rate at t = 1 is 8%. What will be ESG Prime Bank’s equity if it invests in the zero-coupon bond?

Match Microsoft, Boeing, and Cathay Pacific to their respective 2019 Annual Reports. Provide justification for your selections.  No calculations are required.

 Balance Sheet Structure Company A Company B Company C (in percentage) Cash and securities 15 18 37 Accounts Receivable 10 4 18 Inventories 16 1 2 Other Current Assets 5 5 7 Fixed Assets 54 72 36 Total Assets 100 100 100 Short-term debt 1 1 0 Accounts payable 10 5 5 Accruals and others 42 17 33 Long-term debt 13 13 0 Other long-term liabilities 19 21 13 Owners' equity 15 43 49 Total Liabilities & Owners' Equity 100 100 100 Profitability Structure Company A Company B Company C ROTA = EBIT/Total Assets  (%) 10 7 32 Margin  = EBIT/Sales (%) 9 10 39 Total asset turnover = Sales/Total assets 1.13 0.64 0.81 Leverage effect = Pretax ROE/ROTA 6.87 2.08 2.03 Pretax ROE = EBT/Owners' Equity (%) 68 14 65 Tax effect = EAT/EBT = (1-Effective Tax Rate) 0.66 0.89 0.7 After Tax ROE = EAT/Owners' Equity (%) 45 12 45

The senior lending officer has provided you with the data below and you have to consider what analysis your wish to undertake. Please discuss pertinent questions that you would ask the senior lending officer before you commence the analysis and provide a rationale for the analyses you wish to undertake. Note: CF_TD (cash flow to total debt), NI_TA (net income to total assets), CA_CL (current assets to current liabilities), CA_NS (current assets to net sales) and F_OR_NF (fail or not fail).

 CF_TD NI_TA CA_CL CA_NS F_OR_NF -0.4485 -0.4106 1.0865 0.4526 1 -0.5633 2.0114 3.5134 0.1642 1 0.0643 0.0156 1.0077 0.3978 1 -0.1421 -0.0651 0.7066 0.2794 1 0.0351 0.0147 1.5046 0.7080 1 -0.0653 -0.5660 1.3737 0.4032 1 0.0724 -0.0076 1.3723 0.3361 1 0.0713 0.0205 1.3124 0.2497 1 0.0109 0.0011 2.1495 0.6969 1 -0.2777 -0.2316 1.1918 0.6601 1 0.1454 0.0500 1.8762 0.0000 1 0.0115 -0.0032 1.2602 0.6038 1 0.1227 0.1055 1.1434 0.1655 1 -0.2843 -0.2703 1.2722 0.5128 1 0.0777 -0.2316 1.1218 0.7601 1 0.5135 0.1001 2.4871 0.5368 0 0.0769 0.0195 2.0069 0.5304 0 0.3776 0.1075 3.2651 0.3548 0 0.1933 0.0473 2.2506 0.3309 0 0.1184 0.0499 2.5210 0.6925 0 -0.0173 0.0233 2.0538 0.3484 0 0.1703 0.0695 1.7973 0.5174 0 0.1460 0.0518 2.1692 0.5500 0 0.1398 -0.0312 0.4611 0.2643 0 0.1379 0.0728 2.6123 0.5151 0 0.1486 0.0564 2.2347 0.5563 0 0.1633 0.0486 2.3080 0.1978 0 0.5383 5.5000 0.4835 0.4835 0 -0.3330 -0.0854 3.0124 0.4730 0 0.5603 0.1112 4.2918 0.4443 0 0.2029 0.0792 1.9936 0.3018 0 0.1661 0.0351 2.4527 0.1370 0 0.5808 0.0371 5.0594 0.1268 0 0.1446 0.0524 2.2407 0.5403 0 -0.0103 0.0433 2.1538 0.3584 0

Summarize the pros and cons of judgmental and empirically based credit evaluation systems. What would you recommend? Would your recommendation change if you were evaluating Singapore Airlines for a loan during the COVID-19 pandemic? No calculations are required but your answer must relate to the Statement of Financial Position presented.

A company has a choice between a bullet loan and an equivalent amortized loan with a value of \$3,500,000. Calculate the repayment cash flows for a four-year loan with 3.15% pa fixed interest rate bullet loan and the equivalent amortized loan.

 Year Bullet loan repayments Amortized loan repayments 3.15% 2.35% 3.15% 2.35% 1 ? ? 2 ? ? 3 ? ? 4 ? ?

Based on your calculations for the bullet loan repayments and amortized loan repayments, explain why the bank recommends that the amortized loan be taken. If interest rates fell to 2.35% fixed rate, would that alter the bank’s recommendation?

The accounts of 4,500 credit card customers out of a sample of 40,000 that were reviewed did not perform satisfactorily. The credit scores assigned to these applicants when originally assessed had a mean of 70 and standard deviation of 8. The scores of the remaining customers had a mean of 87 and a standard deviation of 12. Assuming these distributions are approximately normal, if the cut-off score was revised upward to 82.

• Complete the following table:
 Creditworthiness High Low Mean credit score 87 70 Standard deviation of credit score 12 8 Probability of receiving credit (%) Probability of being denied credit (%)

(ii) The original default rate on the sample of 40,000 card holders was extremely high. What impact would be setting the cut-off at 82 have on the default rate? Show calculations. Is this adjustment reasonable? Discuss.

(iii) Based on the credit evaluation process. Complete the following table and identify the Type I and Type II errors. All quadrants need to be identified.