In this workout, we're gonna be calculating some credit metrics for an industrial company to help assess the credit risk of their bond with three years to maturity. Now we're gonna be incorporating some new information on ESG risks. There's lots of detail provided here on risks from wastewater, greenhouse gas emissions, and employee concerns. So I suggest you now pause the recording, read through the detail, and then resume when you're ready and we will go through the workout.

The workout asks us to make the necessary adjustments to the financial forecast in the analyst model. And for simplicity, we'll assume there are no changes to depreciation expense, interest expense, or dividend payments. We'll assume that any extra funding requirements for the business come from short-term debt and we're gonna calculate the revised operating margin, current ratio, and debt to total assets. So let's have a look at the information that we've been given. First of all, we've got the forecast income statement for the next three years. We've got the balance sheet for the next three years, and we've got the credit ratios calculated for any adjustments, but also room to make some calculations of the ratios after adjustment. So let's go back up to the income statement and make the first adjustments there. One thing to note is that for simplicity in this workout we're gonna make the changes directly onto the face of the income statement and the balance sheet whereas in reality, what we'd normally want to do is to make the changes to our assumptions and that would then drive all of the calculations that then flow into our forecasts. So let's start off with the carbon tax cost in row 31. And we've been told in the question that the analyst expects the carbon taxes to be 250 million per annum from year two onwards. So let's pop those in. And we need that in year two and year three. In terms of the changes to the operating costs that's as a result of the employee concerns. And we've been told the analyst expects this to be additional operating costs of 100 million per annum in year three onwards. So we've put those changes in. The final change in the income statement is in relation to the fine for wastewater and the analyst expects this to be a fine of 600. I'm gonna include that below the income tax line because we're told that that fine is not going to be tax deductible. So we've included all of the ESG risks in our forecast income statements and that gives us a revised net income forecast for the company for the next three years. Now, let's go down to the balance sheet and make some additional changes there. And we can see that in row 43 of the model, there's a line set up for us to include additional PP&E and that's as a result of the wastewater issue requiring upgrades to production processes. Now that's gonna give rise to additional CapEx. Now that's gonna give rise to additional CapEx in years two and three and that CapEx is gonna be 700 million per year. Now, because that's gonna have a cumulative impact on PP&E, we need to make sure that in year three we include the effects of the previous year's CapEx of 700 plus the additional CapEx of 700 in year three. So we now have incorporated the risks associated with ESG in the balance sheet as well. However, we have a balance sheet now that doesn't balance so we need to make sure that we have some additional short-term debt in our balance sheet to fund all of the effects of those risks. Now what I'm gonna do is use additional short-term debt as a plug in the balance sheet. Effectively, it's going to balance the balance sheet for us. Now, to avoid creating a circular reference, I'm going to make sure that this calculation excludes row 51. So I have to take total assets and then deduct short-term liabilities, deduct long-term liabilities, and then deduct equity.

And that gives me additional short-term debt of 600 in my first forecast year. And when I roll that formula forward we have additional short-term debt of 1500 in year two and 2,400 in year three. And we can see that our balance sheet now balances. So we're now ready to calculate our revised credit metrics. So let's start off with the operating margin. And we simply need to grab the operating profit from our forecasts and divide that by the forecast revenues at the top of our income statement. And we can see that the operating margin, after adjustments, is no different to what was calculated before the adjustments. But when we roll that calculation forward, we can see that in years two and three, the operating margin comes down significantly. And that's because of the effects of the carbon taxes and the employee concerns. Now let's have a look at the current ratio. That's current assets divided by current liabilities. So I'm gonna calculate that by summing our current assets first And then dividing that by the sum of our current liabilities. And that includes our additional short-term debt that we've used as a plug in the balance sheet. And we can see that already in year one the current ratio has come down quite significantly 'cause we've got some additional short-term debt to fund that fine, but also it continues to come down quite dramatically because of that additional funding need for the business. Now the final ratio that we're gonna calculate is debt to total assets. So we need for this to calculate the total debt numbers. Now we're gonna need for this short-term debt, additional short-term debt, and our long-term financial liabilities. And we'll divide that by total assets.

And that that gives us debt to total assets of 33.6% which is already higher than the equivalent value before adjustments. But again, when we roll that forward, we can see that increasing significantly year on year and it ends up at 36% because of all that additional debt that's incurred to fund the various CapEx and operating costs of the business. So we can see that the credit ratios as a result of these adjustments are significantly worse across each of those metrics as a result of these ESG risks.