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H 4/11/2010

Chapter 2 Mini Case

Situation Donna Jamison, a recent graduate of the University of Tennessee with four years of banking experience, was recently brought in as assistant to the chairman of the board of Computron Industries, a manufacturer of electronic calculators. The company doubled its plant capacity, opened new sales offices outside its home territory, and launched an expensive advertising campaign. Computron's results were not satisfactory, to put it mildly. Its board of directors, which consisted of its president and vice-president plus its major stockholders (who were all local business people), was most upset when directors learned how the expansion was going. Suppliers were being paid late and were unhappy, and the bank was complaining about the deteriorating situation and threatening to cut off credit. As a result, Al Watkins, Computrons president, was informed that changes would have to be made, and quickly, or he would be fired. Also, at the board's insistence Donna Jamison was brought in and given the job of assistant to Fred Campo, a retired banker who was Computron's chairman and largest stockholder. Campo agreed to give up a few of his golfing days and to help nurse the company back to health, with Jamison's help. Jamison began by gathering financial statements and other data. Assume that you are Jamison's assistant, and you must help her answer the following questions for Campo.

A B C 25 Computron's Income Statement 26 27 28 INCOME STATEMENT 29 Net sales 30 Cost of Goods Sold 31 Other Expenses 32 Depreciation

2009

2010

$3,432,000 $5,834,400 $2,864,000 $4,980,000 $340,000 $18,900 $209,100 $62,500 $146,600 $58,640 $87,960 $22,000 40% $720,000 $116,960 $17,440 $176,000 -$158,560 -$63,424 -$95,136 $11,000 40%

33 Total Operating Costs 34 Earnings before interest and taxes (EBIT) 35 Less interest 36 Earnings before taxes (EBT) 37 Taxes (40%) 38 Net Income 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 Dividends Tax rate

$3,222,900 $5,816,960

a. (1.) What effect did the expansion have on sales and net income? Answer: See Chapter 2 Mini Case Show Computron's Balance Sheets 2009 Assets Cash and equivalents Short-term investments Accounts receivable Inventories Total current assets Gross fixed assets Less: Accumulated depreciation Net plant and equipment Total assets Liabilities and equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Common Stock Retained Earnings Total Equity Total Liabilites and Equity $9,000 $48,600 $351,200 $715,200 $1,124,000 $491,000 $146,200 $344,800 $1,468,800 2010 $7,282 $20,000 $632,160 $1,287,360 $1,946,802 $1,202,950 $263,160 $939,790 $2,886,592

$145,600 $324,000 $200,000 $720,000 $136,000 $284,960 $481,600 $1,328,960 $323,432 $1,000,000 $460,000 $460,000 $203,768 $97,632 $663,768 $557,632 $1,468,800 $2,886,592

a. (2.) What effect did the expansion have on the asset side of the balance sheet? Answer: See Chapter 2 Mini Case Show Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is shown below for Computron. Computron's Statement of Cash Flows 2010 Operating Activities Net Income before preferred dividends Noncash adjustments Depreciation and amortization Due to changes in working capital Change in accounts receivable Change in inventories Change in accounts payable Change in accruals Net cash provided by operating activities ($95,136 $116,960 ($280,960 ($572,160 $178,400 $148,960 ($503,936

A B C D E F G H 87 88 Investing activities Cash used to acquire fixed assets ($711,950 89 Change in short-term investments $28,600 90 ($683,350 91 Net cash provided by investing activities 92 93 Financing Activities Change in notes payable $520,000 94 Change in long-term debt $676,568 95 Payment of cash dividends ($11,000 96 $1,185,568 97 Net cash provided by financing activities 98 ($1,718 99 Net change in cash and equivilents $9,000 100 Cash and securities at beginning of the year 101 $7,282 102 Cash and securities at end of the year 103 104 105 b. What do you conclude from the statement of cash flows? Answer: See Chapter 2 Mini Case Show 106 107 c. What is free cash flow? Why is it important? What are the five uses of FCF? Answer: See Chapter 2 Mini Case Show 108 d. What is Computrons net operating profit after taxes (NOPAT)? What are operating current assets? 109 What are operating current liabilities? How much net operating working capital and total net operating 110 capital does Computron have? 111 112 Net Operating Profit After Taxes NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets. 113 114 115 NOPAT10 = EBIT x (1-T) = $17,440 x 60% 116 = $10,464 117 118 119 NOPAT09 = EBIT x (1-T) = $209,100 x 60% 120 = $125,460 121 122 123 124 Net Operating Working Capital 125 Those current assets used in operations are called operating current assets, and the current liabilities that 126 result from operations are called operating current liabilities. Net operating working capital is equal to 127 operating current assets minus operating current liabilities. 128 Operating Operating 129 NOWC10 = current current assets liabilities 130 = $1,926,802 $608,960 131 = $1,317,842 132 Operating Operating current 133 NOWC09 = current assets liabilities 134 = $1,075,400 $281,600 135 = $793,800 136 137 Total Net Operating Capital 138 The Total OperatingCapital is Net Operating Working Capital plus any fixed assets. 139 140 TOC10 = NOWC + Fixed assets = $1,317,842 + $939,790 141 = $2,257,632 142 143 144 TOC09 = NOWC + Fixed assets = $793,800 + $344,800 145 = $1,138,600 146 147 148 e. What is Computrons free cash flow (FCF)? What are Computrons net uses of its FCF?

A 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200 201 202 203 204 205 206 207 208 209 210 211 212 213

Free Cash Flow Cash Flow caluclation is the cash flow actually availabe for distribution to investors after Computron's Free the company has made all necessary investments in fixed assets and working capital to sustain ongoing operations. FCF10 = = = NOPAT $10,464.0 -$1,108,568 Net Investment in Operating Capital $1,119,032

Uses of FCF: After-tax interest payment = Reduction (increase) in debt = Payment of dividends = Repurchase (Issue) stock = Purchase (Sale) of short-term investments = Total uses of FCF =

2010 $105,600 -$1,196,568 $11,000 $0 -$28,600 -$1,108,568

f. Calculate Computrons return on invested capital. Computron has a 10% cost of capital (WACC). Do you think Computrons growth added value? 2009 2010 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. ROIC10 = = = ROIC09 = NOPAT $10,464.0 0.5% Operating Capital $2,257,632

NOPAT = $125,460.0 = 11.0%

Operating Capital $1,138,600

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. EVA10 = = = = EVA09 = = = = NOPAT $10,464 $10,464 -$215,299 NOPAT $125,460 $125,460 $11,600 Operating Capital xWACC $2,257,632 x 10% $225,763.2

Operating Capital xWACC $1,138,600 x 10% $113,860.0

h. What happened to Computron's market value added (MVA)? Year-end common stock price Year-end shares outstanding (in millions) Earnings per share (EPS) Dividends per share (DPS) 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. $8.50 100,000 $0.95 $0.11 $6.00 100,000 $0.88 $0.22

A B C 214 MVA10 = Stock price x = $6.00 x 215 = $600,000 216 = $42,368 217 218 219 MVA09 = Stock price x = $8.50 x 220 = $850,000 221 = $186,232 222

D # of shares 100,000

E -

Total common equity $557,632 $557,632

# of shares 100,000

Total common equity $663,768 $663,768