H11CK_APRIL_2023-2024_HWO_TZ1-TZ2_FOA_24HRS

EDINBURGH BUSINESS SCHOOL

H11CK

LENDING AND CREDIT RISK ANALYSIS

FINAL ONLINE ASSESSMENT

April Examination and Assessment Diet 2023-2024

Duration: 24 Hours

This assessment consists of three case studies.

Case Study 1 is worth 40 marks.

Case Study 2 is worth 40 marks.
Case Study 3 is worth 20 marks.

There is no choice in the selection of questions to be answered.

Maximum word limits are provided for all written sections.

Your submission: Please ensure that your submission is a Word based document,
i.e. doc or docx. Pdf and dotx submissions are not acceptable and
will not be marked.

Ethical Commitment: By submitting answers to this paper, I declare that the work I have submitted for the assessment is entirely
my own. I have not taken the ideas, writings or inventions of another person and used these as if they were my own. My submission
is expressed in my own words. Any uses made within this work of the ideas, writings or inventions of others, or of any existing
sources of information (books, journals, websites, generative artificial intelligence, etc.) are properly acknowledged and listed in the
references and/or acknowledgements section.

I understand that infringing this statement would represent an academic misconduct offence subject to disciplinary action according
to the University Regulations and Policy regarding Academic Misconduct, with possible significant consequences for degree
progression and final degree outcome.
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CASE STUDIES

Question 1 Maximum Word Limit 750 words

In order to gain full marks, please show full workings step by step.

Sunny Nursing Home (SNH) is a company based in the UK that manages thousands of
nursing home bedrooms. The company was founded in 1990, separated from an old
hospital in London. The company started with almost a hundred bedrooms and a dozen
of care employees. In recent years, as part of the ageing population, the business has
also had an opportunity to grow. Most of the company assets are real estate. The major
expenses include staffing, food, medical supplies, real estate maintenance and general
living expenses. You are preparing the annual review for the loans provided by your
bank to SNH and reviewing a new loan application to purchase a building that can
immediately provide SNH with an additional 50 bedrooms in Edinburgh City. The asking
price for the building is £15 million, which will be depreciated using the existing
deprecation method as shown below (assuming that the building will be purchased on
01/01/2024). You have access to the balance sheet of the current financial year (2023)
and collected some internal assumptions to forecast the financial statements for the
year ending 2024:

• The company’s sales will be £29 million, of which 50% is on credit.

• The company will receive £5.50 million from debtors and pay £4.0 million to
creditors.
• The gross margin is 70% of sales.
• Supplies will be 8.7 million, of which 60% is on credit.
• Fixed assets were purchased nine years ago (as of 31/12/2023), which are
depreciated at straight-line method over 30 years.
• Administrative and operating costs will be £1.20 million and £2.90 million,
respectively.
• The interest rate on bank loans is 8%. The purchase of the new building will be
fully financed by a new long-term bank loan at the same interest rate and the
interest payment will be made at the end of FY 2024.
• The tax rate is 20%, all paid in cash in the same financial year.

The nursing care industry has been around for a long time, but the industry has been
experiencing new momentum since the aging demographic situation. The industry’s
total sales stood at £100 million in 2022 as compared to £80 million in 2021. The
performance of the industry remains higher than average and care home companies,
on average, are setting a higher price.

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Balance Sheet
12/31/2023
Assets Liabilities
Current Assets $ Liabilities $
Cash 4,909,000 Accounts payable 5,827,000
Accounts Receivable 5,000,000 Short-term bank loans 2,800,000
Inventory 3,900,000 Long term Bank loans 12,000,000
Total Liabilities 20,627,000
Total Current Assets 13,809,000
Owner's equity
Long-term Assets Owner's equity
Building 52,000,000 Retained earning 10,282,000
Accumulated depreciation -15,600,000 36,400,000 Common stock 19,300,000

Total Long-term Assets 36,400,000 Total owner's equity 29,582,000

Total assets 50,209,000 Total equities 50,209,000

The following is the scorecard criteria:

Risk Criteria and Measures W (%) A BBB+ BBB BBB-

12 10 9 8
1. Financial indicators 80%
ROE 20% >23.1 18.1-23.0 13.1-18.0 <13.0
Days Inventory turnover 40% <29 30-35 36-45 >46
Debt-to-equity ratio 20% <40 41-45 46-55 >55
Quick ratio 20% >2.0 1.5-2.0 1.0-1.5 <1.0

2. Economic condition 20%

Life cycle 50% Growth Mature Pioneering Declining
Revenue Market share 20% > 10% 5% - 10% 1% - 5% <1%
Cyclicality 30% Close to 0 anti-cyclical pro-cyclical counter-cyclical

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Required:

(a) Conduct a forecast of the company’s financials for FY 2024 (including the income
statement, balance sheet and cash flows statement) and calculate the ratios
required to feed into the scorecard to calculate the overall credit rating. Will you
recommend granting the new loan to SNH? What security you would ask for?

Show every calculation step and round all results to 0 decimal places for Pounds
amount and percentage.
(30 marks)

(b) Your bank offers conventional and Islamic loans depending on its clients’
preferences. Explain how you can use the following Islamic products to finance
the purchase of the new building. Explain the pros and cons of each product from
a lender’s perspective and explain how the risk profile of these Islamic products
varies:

1. Ijara contract
2. Musharakah with Ijara contract
3. Murabaha contract.
(6 marks)

(c) Consider the following loss probability below:

• 80% of $ 3 million loss

• 15% of $5 million loss
• 3% of $10 million loss
• 1.5% of $20 million loss
• 0.5% of $40 million loss

What are the VaR (value at risk) and ES (expected shortfall) at 98%? Explain the
implication of each.
(4 marks)

Total 40 marks

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Question 2 Maximum Word Limit 750 words

In order to gain full marks, please show full workings step by step.

Ken and Karen got married recently and they are very keen to buy their first home. Their
total gross annual income is £60k and they have a total savings of £35k, the majority of
which were gifts from their parents (i.e. the 'bank-of-mum-and-dad'). They approached
a mortgage advisor who found them a good offer of a 30-year mortgage at 5% with an
85% loan-to-value ratio and a loan-to-income ratio of 4 times. They found their dream
home in Glasgow for £210k.

Required:

(a) Calculate the monthly mortgage payment. How much of the first monthly
mortgage will be the interest payment, and how much is the principal repayment?
Show all calculations and keep 0 decimal places for pounds amount and four
decimal places for interest rate in percentage.
(7 marks)

(b) In which month does the principal repayment exceed the interest payment
component? What will be the outstanding balance of the loan for that month?
(5 marks)

(c) After four years (48 months), the couple now want to move to a bigger and more
expensive house, but the only barrier is the down payment for the new house.
They found the right house, but the best mortgage offer requires them to make a
down payment of at least £80k. They have cash savings of £25k and they hope
that their equity and capital gains from their current house will fill the financing
gap. The market value of their current house is estimated at £240k and the selling
fees will be £3k. How much cash will be available to the couple from the sale of
their current house after exactly 48 months of the current mortgage?
(5 marks)

(d) Briefly, explain the characteristics of each of the following types of corporate
loans. Provide real-life examples of the best use of each loan.

1. Revolving Credit
2. Standby line
3. Customised facilities
4. Syndicated Loans
5. Project Finance
(10 marks)

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(e) ABC Corporation's operating lease payments as per its balance sheet at the date
of 2 January 2024 are given in the following table:

ABS's Operating lease

Year Operating Lease (, £000)
2023 459
2024 430
2025 400
2026 380
2027 350
Thereafter 1,750
Total Lease Payments (MLPs) 3,769
Source: annual report

In the year ending 2023, the lease payment was £520K, and the total assets and
debt balance amounted to £12m and £5m, respectively.

1. Find the debt equivalent of the operating leases using the present value
method if the discount rate is 7%. Use the constant rate method to estimate
the lease term and the minimum lease payments (MLPs).
(6 marks)

2. What would be the effects of operating lease adjustments on the following

selected reported results for the year ending 2023? Indicate whether the
reported results should ‘increase’, ‘decrease’ or have ‘no effect’ and explain
why.

Reported results Effect of the adjustment

Total debt
Average assets
Revenue
Net Income
Operating
Rent expense
Interest expense
Depreciation expenses
EBIT

(4 marks)

3. If the interest rate on debt is 5% and the rent expenses for 2023 were £520k,
calculate the change in interest expenses and change in depreciation
expenses.
(3 marks)

Total 40 marks

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Question 3 Maximum Word Limit 2000 words

In order to gain full marks, please show full workings step by step.

(a) Explain – with an illustrative example – how non-financial firms can manage their
credit risk using the ‘Surety Bond’.
(5 marks)

(b) Company A buys credit insurance from insurance Company B. In the insurance
coverage period, there have been two credit losses to Company A. In the two
incidences, Company A suffers credit losses of $18 million and $80 million.

Explain the credit insurance and find how much Company A can claim if:

• A’s insurance policy is “ground-up coverage” with a deductible of $8

million.
• A’s insurance policy is “stop-loss coverage” with a deductible of $35
million.
(5 marks)

(c) A local bank issues 1,500 fixed-rate mortgages with:

• an average size of 220k

• an average rate of 7.0% p.a.
• an average maturity of 28 years.
• the capital requirement of the risk weighs at 50% with a minimum capital
adequacy ratio of 8% (BASEL III)
• The central bank requires $0.17 for every dollar of deposit.

Calculate:

1. The capital required for the loan portfolio.

2. The deposit needed for the loans.

3. The cash reserve required by the central bank.

4. Complete the following table showing what the mortgage loan portfolio and
its requirements will look like.

Assets (million) Liabilities (million)

Cash reserve required Deposits needed
Mortgage Loans Capital required

(5 marks)

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(d) Apply the Porter’s Five Forces model to assess Coca-Cola’s credit risk as part of
the non-financial assessment.
(5 marks)

Total 20 marks

END OF PAPER

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