Dollinger index

Foundations of New Venture Finance 289

firm is in danger of bankruptcy or is in the safe range. Ventures with Z-scores in the

intermediate range need watching.

The Bankruptcy Reform Act of 1978. The Bankruptcy Reform Act of 1978 codifies

three specific types of voluntary bankruptcy. These are known by their chapter desig-

nations: Chapter 7, Chapter 11, and Chapter 13. Each of these details a separate man-

ner by which the firm and its creditors can seek protection. A venture can be forced into

bankruptcy (involuntary) by its creditors under the following conditions:

• When three or more creditors have aggregate claims that total $5,000 more than the
  value of their collateral


• When there is one or more such creditors and the total number of creditors and
  claimholders is fewer than 12


• When any general partner in a limited partnership begins legal proceedings
  Failure to pay on time is a sufficient criterion for a filing of involuntary bankruptcy, even
  if the firm has the ability to pay. One way to avoid involuntary bankruptcy is to make
  sure that no three creditors are owed more than $5,000 in the aggregate and that the
  firm has more than 12 claim holders.
  A Chapter 7 bankruptcy provides for the voluntary or involuntary liquidation of the
  firm. The process requires an accounting of all of the assets of the debtor, identification

Model 1: The Public Firm

Z-score = 0.012 (WC/TA) + 0.014 (RE/TA) + 0.033 (EBIT) + 0.006 (MVE/TL) + 0.999 (sales/TA)

If the Z-score is less than 1.81, the firm is in danger of bankruptcy.

If the Z-score is greater than 2.99, the firm is considered safe.

Values between 1.81 and 2.99 are considered cautionary.

Model 2: The Private Firm

Z-score = 0.717 (WC/TA) + 0.847 (RE/TA) + 3.107 (EBIT/T) + 0.998 (sales/TA)

If the Z-score is less than 1.23, the firm is in danger of bankruptcy.

If the Z-score is greater than 2.90, the firm is considered safe.

Values between 1.23 and 2.90 are considered cautionary.

WC = Working capital

RE = Retained earnings

EBIT = Earnings before interest and taxes

MVE = Market value of the equity

Sales = Sales

NW = Net worth

TA = Total assets

TL = Total liabilities

SOURCE: E. Altman, R. Haldeman, and P. Narayanan, “ZETA-Analysis: A New Model to Identify Bankruptcy Risk,” Journal of
Banking and Finance, June 1977: 29-54.

TABLE 7.4 Predictive Model of Bankruptcy