Question 1
Chapter 2 Mini Case
Situation
"Jenny Cochran, a graduate of The University of OBO with 4 years of experience as an equities analyst, was recently brought in as assistant to the chairman of the board of Computron Industries, a manufacturer of computer components.
During the previous year, Computron had doubled its plant capacity, opened new sales offices outside its home territory, and launched an expensive advertising campaign. Cochran was assigned to evaluate the impact of the changes. She began by gathering financial statements and other data."
| Computron's Income Statement |
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2015 |
2016 |
| INCOME STATEMENT |
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| Net sales |
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$ 3,432,000 |
$ 5,834,400 |
| Cost of Goods Sold Except Depr. |
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|
2,864,000 |
4,980,000 |
| Depreciation and amortization |
|
|
18,900 |
116,960 |
| Other Operating Expenses |
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|
|
340,000 |
720,000 |
| Total Operating Costs |
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$ 3,222,900 |
$ 5,816,960 |
| Earnings before interest and taxes (EBIT) |
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|
$ 209,100 |
$ 17,440 |
| Less interest |
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|
62,500 |
176,000 |
| Pre-tax earnings |
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$ 146,600 |
$ (158,560) |
| Taxes (40%) |
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|
58,640 |
(63,424) |
| Net Income |
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$ 87,960 |
$ (95,136) |
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| Dividends |
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$22,000 |
$11,000 |
| Tax rate |
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40% |
40% |
a. (1.) What effect did the expansion have on sales and net income?
a. (2.) What effect did the expansion have on the asset side of the balance sheet?
b. What do you conclude from the statement of cash flows?
c. What is free cash flow? Why is it important? What are the five uses of FCF?
d. What is Computron's net operating profit after taxes (NOPAT)? What are operating current assets? What are operating current liabilities? How much net operating working capital and total net operating capital does Computron have?
e. What is Computron's free cash flow (FCF)? What are Computron's "net uses" of its FCF?
f. Calculate Computron's return on invested capital. Computron has a 10% cost of capital (WACC). Do you think Computron's growth added value?
g. What is Computron's EVA? The after-tax cost of capital was 10 percent in both years.
h. What happened to Computron's market value added (MVA)?
i. Assume that a corporation has $100,000 of taxable income from operations plus $5,000 of interest income and $10,000 of dividend income. What is the company's tax liability?
Operating income = $100,000
Interest income = $5,000
Dividends = $10,000
Taxable dividends=
Taxable Income:
j. Assume that you are in the 25 percent marginal tax bracket and that you have $5,000 to invest. You have narrowed your investment choices down to California bonds with a yield of 7 percent or equally risky ExxonMobil bonds with a yield of 10 percent.
Which one should you choose and why? At what marginal tax rate would you be indifferent to the choice between California and ExxonMobil bonds?
Question 2
a. Using the financial statements shown below, calculate net operating working capital, total net operating capital, net operating profit after taxes, free cash flow, and return on invested capital for the most recent year.
| Lan & Chen Technologies: Income Statements for Year Ending December 31 |
| (Thousands of Dollars) |
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2016 |
2015 |
| Sales |
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$945,000 |
$900,000 |
| Expenses excluding depreciation and amortization |
812,700 |
774,000 |
| EBITDA |
|
|
|
$132,300 |
$126,000 |
| Depreciation and amortization |
|
33,100 |
31,500 |
| EBIT |
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|
|
$99,200 |
$94,500 |
| Interest Expense |
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|
10,470 |
8,600 |
| EBT |
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$88,730 |
$85,900 |
| Taxes (40%) |
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|
35,492 |
34,360 |
| Net income |
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$53,238 |
$51,540 |
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| Common dividends |
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$43,300 |
$41,230 |
| Addition to retained earnings |
|
$9,938 |
$10,310 |
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| Lan & Chen Technologies: December 31 Balance Sheets |
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| (Thousands of Dollars) |
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| Assets |
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2016 |
2015 |
| Cash and cash equivalents |
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$47,250 |
$45,000 |
| Short-term investments |
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|
3,800 |
3,600 |
| Accounts Receivable |
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283,500 |
270,000 |
| Inventories |
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|
141,750 |
135,000 |
| Total current assets |
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$476,300 |
$453,600 |
| Net fixed assets |
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330,750 |
315,000 |
| Total assets |
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$807,050 |
$768,600 |
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| Liabilities and equity |
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| Accounts payable |
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$94,500 |
$90,000 |
| Accruals |
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47,250 |
45,000 |
| Notes payable |
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26,262 |
9,000 |
| Total current liabilities |
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$168,012 |
$144,000 |
| Long-term debt |
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94,500 |
90,000 |
| Total liabilities |
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$262,512 |
$234,000 |
| Common stock |
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|
444,600 |
444,600 |
| Retained Earnings |
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|
99,938 |
90,000 |
| Total common equity |
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$544,538 |
$534,600 |
| Total liabilities and equity |
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$807,050 |
$768,600 |
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| Key Input Data |
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| Tax rate |
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40% |
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b. Assume that there were 15 million shares outstanding at the end of the year, the year-end closing stock price was $65 per share, and the after-tax cost of capital was 8%. Calculate EVA and MVA for the most recent year.
Question 3
| Joshua & White Technologies: December 31 Balance Sheets |
| (Thousands of Dollars) |
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| Assets |
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2016 |
2015 |
| Cash and cash equivalents |
$21,000 |
$20,000 |
| Short-term investments |
|
3,759 |
3,240 |
| Accounts Receivable |
|
52,500 |
48,000 |
| Inventories |
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|
84,000 |
56,000 |
| Total current assets |
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$161,259 |
$127,240 |
| Net fixed assets |
|
218,400 |
200,000 |
| Total assets |
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$379,659 |
$327,240 |
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| Liabilities and equity |
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| Accounts payable |
|
$33,600 |
$32,000 |
| Accruals |
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|
12,600 |
12,000 |
| Notes payable |
|
19,929 |
6,480 |
| Total current liabilities |
|
$66,129 |
$50,480 |
| Long-term debt |
|
67,662 |
58,320 |
| Total liabilities |
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$133,791 |
$108,800 |
| Common stock |
|
183,793 |
178,440 |
| Retained Earnings |
|
62,075 |
40,000 |
| Total common equity |
|
$245,868 |
$218,440 |
| Total liabilities and equity |
$379,659 |
$327,240 |
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| Joshua & White Technologies December 31 Income Statements |
| (Thousands of Dollars) |
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2016 |
2015 |
| Sales |
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$420,000 |
$400,000 |
| COGS except excluding depr. and amort. |
300,000 |
298,000 |
| Depreciation and Amortization |
19,660 |
18,000 |
| Other operating expenses |
27,600 |
22,000 |
| EBIT |
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$72,740 |
$62,000 |
| Interest Expense |
|
5,740 |
4,460 |
| EBT |
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|
$67,000 |
$57,540 |
| Taxes (40%) |
|
26,800 |
23,016 |
| Net Income |
|
$40,200 |
$34,524 |
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| Common dividends |
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$18,125 |
$17,262 |
| Addition to retained earnings |
$22,075 |
$17,262 |
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| Other Data |
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2016 |
2015 |
| Year-end Stock Price |
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$90.00 |
$96.00 |
| # of shares (Thousands) |
4,052 |
4,000 |
| Lease payment (Thousands of Dollars) |
$20,000 |
$20,000 |
| Sinking fund payment (Thousands of Dollars) |
$5,000 |
$5,000 |
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a. Has Joshua & White's liquidity position improved or worsened? Explain.
b. Has Joshua & White's ability to manage its assets improved or worsened? Explain.
c. How has Joshua & White's profitability changed during the last year?
d. Perform an extended Du Pont analysis for Joshua & White for 2008 and 2009.
e. Perform a common size analysis. What has happened to the composition (that is, percentage in each category) of assets and liabilities?
f. Perform a percent change analysis. What does this tell you about the change in profitability and asset utilization?
Question 4
Chapter 3 Mini Case
The first part of the case, presented in Chapter 2, discussed the situation of Computron Industries after an expansion program. A large loss occurred in 2016, rather than the expected profit. As a result, its managers, directors, and investors are concerned about the firm's survival.
| Input Data: |
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2015 |
2016 |
2017E |
| Year-end common stock price |
$8.50 |
$6.00 |
$12.17 |
| Year-end shares outstanding |
100,000 |
100,000 |
250,000 |
| Tax rate |
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40% |
40% |
40% |
| Lease payments |
|
$40,000 |
$40,000 |
$40,000 |
Jenny Cochran was brought in as assistant to Computron's chairman, who had the task of getting the company back into a sound financial position. Cochran must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions to take. Your assignment is to help her answer the following questions, using the recent and projected financial information shown next. Provide clear explanations, not yes or no answers.
| Balance Sheets |
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| Assets |
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2015 |
2016 |
2017E |
| Cash and equivalents |
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$9,000 |
$7,282 |
$14,000 |
| Short-term investments |
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$48,600 |
$20,000 |
$71,632 |
| Accounts receivable |
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$351,200 |
$632,160 |
$878,000 |
| Inventories |
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$715,200 |
$1,287,360 |
$1,716,480 |
| Total current assets |
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$1,124,000 |
$1,946,802 |
$2,680,112 |
| Gross Fixed Assets |
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$491,000 |
$1,202,950 |
$1,220,000 |
| Less Accumulated Dep. |
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$146,200 |
$263,160 |
$383,160 |
| Net Fixed Assets |
|
$344,800 |
$939,790 |
$836,840 |
| Total Assets |
|
$1,468,800 |
$2,886,592 |
$3,516,952 |
| |
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| Liabilities and equity |
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| Accounts payable |
|
$145,600 |
$324,000 |
$359,800 |
| Notes payable |
|
$200,000 |
$720,000 |
$300,000 |
| Accruals |
|
|
$136,000 |
$284,960 |
$380,000 |
| Total current liabilities |
|
$481,600 |
$1,328,960 |
$1,039,800 |
| Long-term bonds |
|
$323,432 |
$1,000,000 |
$500,000 |
| Total liabilities |
|
$805,032 |
$2,328,960 |
$1,539,800 |
| Common stock (100,000 shares) |
$460,000 |
$460,000 |
$1,680,936 |
| Retained earnings |
|
$203,768 |
$97,632 |
$296,216 |
| Total common equity |
|
$663,768 |
$557,632 |
$1,977,152 |
| Total liabilities and equity |
$1,468,800 |
$2,886,592 |
$3,516,952 |
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| Income Statements |
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|
2015 |
2016 |
2017E |
| Net sales |
|
|
$3,432,000 |
$5,834,400 |
$7,035,600 |
| Costs of Goods Sold Except Depr. |
$2,864,000 |
$4,980,000 |
$5,800,000 |
| Depreciation and amortization |
$18,900 |
$116,960 |
$120,000 |
| Other Expenses |
|
$340,000 |
$720,000 |
$612,960 |
| Total Operating Cost |
|
$3,222,900 |
$5,816,960 |
$6,532,960 |
| Earnings before interest and taxes (EBIT) |
$209,100 |
$17,440 |
$502,640 |
| Less interest |
|
$62,500 |
$176,000 |
$80,000 |
| Pre-tax earnings |
|
$146,600 |
($158,560) |
$422,640 |
| Taxes (40%) |
|
$58,640 |
($63,424) |
$169,056 |
| Net Income before preferred dividends |
$87,960 |
($95,136) |
$253,584 |
| EPS |
|
|
$0.880 |
($0.951) |
$1.014 |
| DPS |
|
|
$0.220 |
$0.110 |
$0.220 |
| Book Value Per Share |
|
$6.638 |
$5.576 |
$7.909 |
| |
|
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|
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Cochran must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers.
a. Why are ratios useful? What three groups use ratio analysis and for what reasons?
b. (1.) Calculate the current and quick ratios based on the projected balance sheet and income statement data.
(2.) What can you say about the company's liquidity position? We often think of ratios as being useful (1) to managers to help run the business, (2) to bankers for credit analysis, and (3) to stockholders for stock valuation. Would these different types of analysts have an equal interest in the liquidity ratios?
c. Calculate the inventory turnover, days sales outstanding (DSO), fixed assets turnover, operating capital requirement, and total assets turnover. How does Computron's utilization of assets stack up against other firms in its industry?
d. Calculate the debt ratio, liabilities-to-assets ratio, times-interest-earned, and EBITDA coverage ratios. How does Computron compare with the industry with respect to financial leverage? What can you conclude from these ratios?
e. Calculate the profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios?
f. Calculate the price/earnings ratio, price/cash flow ratio, and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?
g. Perform a common size analysis and percent change analysis. What do these analyses tell you about Computron?
h. Use the extended DuPont equation to provide a summary and overview of Computron's projected financial condition. What are the firm's major strengths and weaknesses?
i. What are some potential problems and limitations of financial ratio analysis?
j. What are some qualitative factors analysts should consider when evaluating a company's likely future financial performance?