In respect to the firm at hand, JamesHardie Industries involvement with debt securities as a model for funding investments should be put under immense scrutiny. The firm’s consideration to engage in debt securities as model for attracting potential investment is highly determined by the credit-rating it
possesses.
There are several risks which are involved with this form of securities and they mainly include ofinherent and control risks.
The risks are concerned with determining whether or not the assumptions made while performing analysis for the security is inclined to any form of material misstatements. While assessing the inherent risk of a given
firm the following variables are utilized for complete assessment:(1). the objectives of the management: when James Hardies’ Industry management team embarks on deploying certain strategies in the effort to minimize the
risk, it might find itself on a challenging position upon which it will be impossible to match the
assumptions held, while sourcing for funds, with the presiding risk-level within the business
environment(Public Company Accounting Oversight Board 2004, p 1).
Being an international Company, James Hardie Industries management might opt to reduce those risks which are
ascertained with investment loss from thoseshifts witnessed in the international market. As a result, the
Company will be forced to conform to hedge accounting which increases risk certainty of the firm since it
does not match with the formulated Generally Accounting Principles (GAAPs).(2). the complexity of the
features of the deduced variables: in our case, the approach taken to deduce credit worthiness of James
Hardie Industries is simple and direct. The computation of the Altman Algorithm Z scores is based upon direct
and easy-to derive variables which decrease the amount of possible inherent risk. However, in other cases,
the composite nature of variables used in determining the credit worthiness might bring about a substantial
increment in inherent risk since the formulated measurement and disclosure approach is considered to be
inconsistent with the Generally Accepted Accounting Principles. In our case, the interest rate payment is
not, in any way, influenced by interactions of external facets and thus, reducing the level of risks involved
with the assumption about the resultant fair value of the debt securities (Public Company Accounting
Oversight Board 2004, p 1).
It should also be noted that the Altman Z-score methodology of calculating credit worthiness of a company
does not involve tedious computations or rather comprehension since results of the calculated ratios are
rated on a scale of 1 to 3. In the case that the Company’s score falls below the score 3, it is termed unsafe
to invest in since such a lower ratio reflects the fact that the given company possess a significant higher
probability of bankruptcy.
Z = 6.56 (X1) + 3.26 (X2) + 6.72 (X3) + 1.06 (X4)
X1 = working capital/total assets,X2 = retained earnings/total assets,
X3 = earnings before interest and taxes/total assets,X4 =Book value of equity/ total liabilities
2010 2011 2012
Working capital/Total assets (X1) 0.02 0.07 0.20
Retained earnings/ Total assets (X2) -0.20 -0.40 -0.09
EBIT/Total assets (X3) 0.07 -0.01 0.04
Market value of equity/ Total Liabilities (X4) 1.57 1.69 1.88
Z Score 1.61 0.88 3.33
The value obtained from the calculations tends to significantly increases towards the Z-score value 3.0. In
2010 the value calculated depicts a Z-score of 1.63 which drops to 0.88 in 2011 and later to 3.3 in 2012. The
current Z-score of 3.3 is enough to proclaim that the Company is safe to invest in. (3). The experience of
the firm in respect to the debt security: the fact that James Hardie Industries is involved with form of
arrangement might cause an increment on the amount of risk involved.This increment in the amount of credit
risk is likely to be caused by the different natures of the transactions involved.
Inexperienced firms are likely to post wrong entries for particular transactions which might trigger the
element of error. (4). Inherent nature of risk assessment is also determined through the establishment of
whether or not the variables used in ascertaining the credit worthiness of the Company are formulated in
terms of freestanding statements or on embedded facets of a predisposed contract. When the management of the
firm embarks on utilizing the embedded version of evaluating concerned variables, it becomes certain that the
nature of risk involved can be increased all the same(Public Company Accounting Oversight Board 2004, p 1).
(5).The credit worthiness of the company is influenced by external facets which affect the assumptions
utilized while ascertaining the Z-score of the Company at hand. Such external facets as credit risks, market
risks, basis risk as well as legal risks are showcased and whether or not they appear on a company’s
financial obligations determines the credit worthiness of the Company. Credit risks are concerned with
exposing a firm to possible risks which might result from a company’s inability to meet its financial
obligation.
Market risks expose a firm to possible risks which can result from the unfavorable shifts in the securities
market.In our case, the Company: James Hardie although an Australian Company, has penetrated the American
Market and in that effect there are possible risks which can result from such fluctuations as shifts in the
interest and foreign exchange rates.
Basis risk is a form of risk that exposes a firm to possible risks of inefficient equivocation activities.
The difference which exists between the fair value of the hedged transaction and that of the variables used
in establishing the credit worthiness of James Hardie Industries is checked constantly to deduce on whether
the hedging transaction is nearing inefficiency.
In our case, the variables used in determining the credit worthiness of the Company and thus placing it on a
fair pricing strategy upon which the amount of debt securities expected can be accessed are reflected through
the various ratios used to compute the Z- score.
Z-score which is later put on a scale of 1 to 3 with a lower value depicting ineffective as well as unsafe
position of the Company to undertake the investment project.
The fact that James Hardie Industries is operating under a growing sector of the economy minimizes possible
inherent risks since variables used in determining the credit worthiness of the Company are valued basing on
the true assumptions used in the aforesaid process. Furthermore, the Company’s Z-score is placed highly on
the Z-score table thus depicting reliability and assurance of the Company to meet its financial obligations.
In that case, the degree of inherent risk is minimized greatly due to assurance in the prepayments of both
interest rates as well the principal amount of the debt security (Public Company Accounting Oversight Board
2004, p 1).
In the case of control risk methodology of assessing the credit worthiness of the Company, the fundamental
analysis rests on the identification of the possible misstatements of those assumptions used in deriving the
Z-Score: the Altman Algorithm. This phenomenon goes way beyond ascertaining the reasonableness and
appropriateness of the credit-establishment model utilized in the aforementioned process. Furthermore, the
variables used in the process are also put to task and their respective validity tested for
reliability(Public Company Accounting Oversight Board 2004, p 1).
2010 2011 2012
EBIT Cover -1.91 11.22 15.43
EBITDA Cover -1.91 11.22 21.25
FOCF/TD 0.08 0.03 -0.02
FFO/TD 0.08 0.06 0.18
ROC -0.01 0.10 0.15
Op Income/Sales -0.08 -0.30 0.49
LT Debt/Capital 0.33 0.11 0
Total Debt/Capital 0.80 0.46 0.76
2010 2011 2012
EBIT Cover CCC AA AA
EBITDA Cover CCC A AA
FOCF/TD BB BB B
FFO/TD B B B
ROC CCC B BBB
Op Income/Sales CCC AAA AAA
LT Debt/Capital AA AAA AAA
Total Debt/Capital B A B
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