Ch02 Mini Case
| 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 | ||||||
| 2015 | 2016 | |||||
| INCOME STATEMENT | ||||||
| Net sales | $ 3,432,000 | $ 5,834,400 | ||||
| Cost of Goods Sold Except Depr. | 2,864,000 | 4,980,000 | ||||
| Depreciation and amortization | 18,900 | 116,960 | ||||
| Other Operating Expenses | 340,000 | 720,000 | ||||
| Total Operating Costs | $ 3,222,900 | $ 5,816,960 | ||||
| Earnings before interest and taxes (EBIT) | $ 209,100 | $ 17,440 | ||||
| Less interest | 62,500 | 176,000 | ||||
| Pre-tax earnings | $ 146,600 | $ (158,560) | ||||
| Taxes (40%) | 58,640 | (63,424) | ||||
| Net Income | $ 87,960 | $ (95,136) | ||||
| Dividends | $22,000 | $11,000 | ||||
| Tax rate | 40% | 40% | ||||
| a. (1.) What effect did the expansion have on sales and net income? | ||||||
| Computron’s Balance Sheets | ||||||
| 2015 | 2016 | |||||
| Assets | ||||||
| Cash and equivalents | $ 9,000 | $ 7,282 | ||||
| Short-term investments | 48,600 | 20,000 | ||||
| Accounts receivable | 351,200 | 632,160 | ||||
| Inventories | 715,200 | 1,287,360 | ||||
| Total current assets | $ 1,124,000 | $ 1,946,802 | ||||
| Gross fixed assets | $ 491,000 | $ 1,202,950 | ||||
| Less: Accumulated depreciation | 146,200 | 263,160 | ||||
| Net plant and equipment | $ 344,800 | $ 939,790 Bart Kreps: Property, Plant and Equipment minus Depreciation |
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| Total assets | $ 1,468,800 | $ 2,886,592 | ||||
| Liabilities and equity | ||||||
| Accounts payable | $ 145,600 | $ 324,000 | ||||
| Notes payable | 200,000 | 720,000 | ||||
| Accruals | 136,000 | 284,960 | ||||
| Total current liabilities | $ 481,600 | $ 1,328,960 | ||||
| Long-term bonds | $ 323,432 | $ 1,000,000 | ||||
| Common Stock | 460,000 | 460,000 | ||||
| Retained Earnings | 203,768 | 97,632 | ||||
| Total Equity | $ 663,768 | $ 557,632 | ||||
| Total Liabilites and Equity | $ 1,468,800 | $ 2,886,592 | ||||
| a. (2.) What effect did the expansion have on the asset side of the balance sheet? | ||||||
| Computron’s Statement of Cash Flows Bart Kreps: The statement of cash flows provides information about cash inflows and outflows during an accounting period. |
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| 2016 | ||||||
| Operating Activities | ||||||
| Net Income before preferred dividends | $ (95,136) | |||||
| Noncash adjustments | ||||||
| Depreciation and amortization | 116,960 | |||||
| Due to changes in working capital | ||||||
| Change in accounts receivable | (280,960) Bart Kreps: Change is negative because accounts receivable went up in 2001. This means that more sales revenue has been reflected in net income than has been collected in cash. |
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| Change in inventories | (572,160) Bart Kreps: Inventories went up meaning that Computron used cash to purchase inventories. |
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| Change in accounts payable | 178,400 Bart Kreps: This is positive because accounts payable went up. Computron bought on credit from suppliers and did not dispense cash. |
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| Change in accruals | 148,960 Bart Kreps: Accruals increased in 2001. Cash flow is positive because it recognizes an increased expense prior to the payment of cash. |
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| Net cash provided by operating activities | $ (503,936) | |||||
| Investing activities | ||||||
| Cash used to acquire fixed assets | $ (711,950) Bart Kreps: Make sure to add back annual Depreciation to Net PP&E. |
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| Change in short-term investments | 28,600 Bart Kreps: Short term investments went down in 2001. Computron received cash through the sale or maturity of these assets. |
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| Net cash provided by investing activities | $ (683,350) | |||||
| Financing Activities | ||||||
| Change in notes payable | $ 520,000 Bart Kreps: Notes payable went up in 2001. Computron received cash from creditors. |
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| Change in long-term debt | 676,568 Bart Kreps: Long term debt went up in 2001. Computron received cash from creditors. |
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| Payment of cash dividends | (11,000) Bart Kreps: Computron used cash to pay dividends to shareholders. |
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| Net cash provided by financing activities | $ 1,185,568 | |||||
| Net change in cash and equivilents | $ (1,718) | |||||
| Cash and securities at beginning of the year | 9,000 | |||||
| Cash and securities at end of the year | $ 7,282 | |||||
| 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? | ||||||
| Net Operating Profit After Taxes | ||||||
| NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets. | ||||||
| 2016 | NOPAT = | EBIT | x | ( 1 – T ) | ||
| = | x | |||||
| = | ||||||
| 2015 | NOPAT = | EBIT | x | ( 1 – T ) | ||
| = | x | |||||
| = | ||||||
| Net Operating Working Capital | ||||||
| Those current assets used in operations are called operating current assets, and the current liabilities that result from operations are called operating current liabilities. Net operating working capital is equal to operating current assets minus operating current liabilities. | ||||||
| 2016 | NOWC = | Operating current assets | – | Operating current liabilities | ||
| = | – | |||||
| = | ||||||
| 2015 | NOWC = | Operating current assets | – | Operating current liabilities | ||
| = | – | |||||
| = | ||||||
| Total Net Operating Capital | ||||||
| The Total OperatingCapital is Net Operating Working Capital plus any fixed assets. | ||||||
| 2016 | TOC = | NOWC | + | Fixed assets | ||
| = | + | |||||
| = | ||||||
| 2015 | TOC = | NOWC | + | Fixed assets | ||
| = | + | |||||
| = | ||||||
| e. What is Computron’s free cash flow (FCF)? What are Computron’s “net uses” of its FCF? | ||||||
| Free Cash Flow | ||||||
| Computron’s Free Cash Flow caluclation is the cash flow actually availabe for distribution to investors after the company has made all necessary investments in fixed assets and working capital to sustain ongoing operations. | ||||||
| 2016 | FCF = | NOPAT | – | Net Investment in Operating Capital | ||
| = | – | |||||
| = | ||||||
| Uses of FCF: | 2016 | |||||
| After-tax interest payment = | ||||||
| Reduction (increase) in debt = | ||||||
| Payment of dividends = | ||||||
| Repurchase (Issue) stock = | ||||||
| Purchase (Sale) of short-term investments = | ||||||
| Total uses of 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? | ||||||
| 2015 | 2016 | |||||
| Cost of Capital (WACC) | 10% | 10% | ||||
| Return on Invested Capital | ||||||
| The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital. | ||||||
| 2016 | ROIC = | NOPAT | ÷ | Operating Capital | ||
| = | ||||||
| = | ||||||
| 2015 | ROIC = | NOPAT | ÷ | Operating Capital | ||
| = | ||||||
| = | ||||||
| Operating Profitability | ||||||
| The operating profitability (OP) ratio shows how many dollars of operating profit are generated by each dollar of sales. | ||||||
| 2016 | OP = | NOPAT | ÷ | Sales | ||
| = | ||||||
| = | ||||||
| 2015 | OP = | NOPAT | ÷ | Sales | ||
| = | ||||||
| = | ||||||
| Capital Utilization | ||||||
| The capital utilization (CR) ratio shows how many dollars of operating assets are needed to generated a dollar of sales. | ||||||
| 2016 | CR = | Total Op. Cap. | ÷ | Sales | ||
| = | ||||||
| = | ||||||
| 2015 | CR = | Total Op. Cap. | ÷ | Sales | ||
| = | ||||||
| = | ||||||
| Operating profitability declined and the capital utlization worsened, each contributing to the big decrease in ROIC. | ||||||
| g. What is Computron’s EVA? The after-tax cost of capital was 10 percent in both years. | ||||||
| Economic Value Added | ||||||
| Economic Value Added represents Computron’s residual income that remains after the cost of all capital, including equity capital, has been deducted. | ||||||
| 2016 | EVA = | NOPAT | – | Operating Capital x | WACC | |
| = | – | x | 10% | |||
| = | – | $0.0 | ||||
| = | ||||||
| 2015 | EVA = | NOPAT | – | Operating Capital x | WACC | |
| = | $0 | – | $0 | x | 10% | |
| = | $0 | – | $0.0 | |||
| = | $0 | |||||
| h. What happened to Computron’s market value added (MVA)? | ||||||
| Year-end common stock price | $8.50 | $6.00 | ||||
| Year-end shares outstanding (in millions) | 100,000 | 100,000 | ||||
| Earnings per share (EPS) | ||||||
| Bart Kreps: An increase in Earnings Per Share either means the company is generating more net income or they are reducing the amount of common shares outstanding. Shares that are repurchased by the company are called Treasury stocks. | Dividends per share (DPS) | Bart Kreps: The same rational holds for interpreting Dividends Per Share data. If the company increases their dividend payout policies or reduces shares outstanding, DPS will increase. | $0.11 | $0.22 | ||
| Market Value Added | ||||||
| Assume that the market value of debt is equal to the book value of debt. In this case, Market Value Added (MVA) is the difference between the market value of Computron’s stock and the amount of equity capital supplied by shareholders. | ||||||
| 2016 | MVA = | Stock price | x | # of shares | – | Total common equity |
| = | x | – | ||||
| = | $0 | – | ||||
| = | ||||||
| 2015 | ||||||
| MVA = | Stock price | x | # of shares | – | Total common equity | |
| = | x | – | ||||
| = | $0 | – | ||||
| = | ||||||
| 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: | ||||||
| Corporate Tax Rates | ||||||
| If a corporation’s taxable income is between: | It pays this amount on the base of the bracket: | Plus this percentage on the excess over the base | ||||
| (1) | (2) | (3) | (4) | |||
| $0 | $50,000 | $0 | 15.0% | |||
| $50,000 | $75,000 | $7,500 | 25.0% | |||
| $75,000 | $100,000 | $13,750 | 34.0% | |||
| $100,000 | $335,000 | $22,250 | 39.0% | |||
| $335,000 | $10,000,000 | $113,900 | 34.0% | |||
| $10,000,000 | $15,000,000 | $3,400,000 | 35.0% | |||
| $15,000,000 | $18,333,333 | $5,150,000 | 38.0% | |||
| $18,333,333 | and up | $6,416,667 | 35.0% | |||
| Base amount of tax | <– Might need a VLOOKUP formula. | |||||
| Marginal tax rate in bracket | <– Might need a VLOOKUP formula. | |||||
| Income above base of bracket | <– Might need a VLOOKUP formula. | |||||
| Tax on income above base | ||||||
| Total tax liability: | ||||||
| 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? | ||||||
| Taxable vs. Tax Exempt bonds | ||||||
| ExxonMobil bonds at 10% vs. California muni bonds at 7% | ||||||
| Amount to invest | $5,000 | |||||
| ExxonMobil Yield | 10% | |||||
| California Yield | 7% | |||||
| Tax Rate | 25.0% | |||||
| ExxonMobil = | Yield * (Investment) | – | Yield * (Investment) * (Tax Rate) | |||
| ExxonMobil = | ||||||
| California = | Yield * (Investment) | – | 0 | |||
| California = | ||||||
| Tax rate which you would be indifferent | ||||||
| Solve for T | ||||||
| Muni Yield = | Corp Yield *(1-Tax rate) |