A B C D E F G H

1 3/30/2003
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3 Chapter 6 Mini Case
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5 Situation
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7 Donna Jamison, a 1999 graduate of the University of Tennessee with four years of banking experience, was recently brought
8 in as assistant to the chairman of the board of Computron Industries, a manufacturer of electronic calculators.
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11 The company doubled its plant capacity, opened new sales offices outside its home territory, and launched an expensive
12 advertising campaign. Computron's results were not satisfactory, to put it mildly. Its board of directors, which consisted of
13 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
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complaining about the deteriorating situation and threatening to cut off credit. As a result, Al Watkins, Computron’s
15 president, was informed that changes would have to be made, and quickly, or he would be fired. Also, at the board's
16 insistence Donna Jamison was brought in and given the job of assistant to Fred Campo, a retired banker who was
17 Computron's chairman and largest stockholder. Campo agreed to give up a few of his golfing days and to help nurse the
18 company back to health, with Jamison's help.
19 Jamison began by gathering financial statements and other data.
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21 Assume that you are Jamison's assistant, and you must help her answer the following questions for Campo.
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 A B C D E F G H
23 Computron's Income Statement
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25 2002 2003
26 INCOME STATEMENT
27 Net sales $3,432,000 $5,834,400
28 Cost of Goods Sold $2,864,000 $4,980,000
29 Other Expenses $340,000 $720,000
30 Depreciation $18,900 $116,960
31 Total Operating Costs $3,222,900 $5,816,960
32 Earnings before interest and taxes (EBIT) $209,100 $17,440
33 Less interest $62,500 $176,000
34 Earnings before taxes (EBT) $146,600 -$158,560
35 Taxes (40%) $58,640 -$63,424
36 Net Income $87,960 -$95,136
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38 Tax rate 40% 40%
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40 a. (1.) What effect did the expansion have on sales and net income? Answer: See Chapter 6 Mini Case Show
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43 Statement of Retained Earnings
44 The statement of retained earnings takes the previous year's balance of retained earnings, adds the current year's net
45 income, and then subtracts dividends paid to common stockholders. The end result is the new balance of retained earnings.
46 Computron's statement is shown below:
47 2003
48 Balance of Retained Earnings, Dec. 31, 2002 $203,768.0
49 Add: Net Income, 2003 ($95,136.0)
50 Less: Dividends to common stockholders ($11,000.0)
51 Balance of Retained Earnings, Dec. 31, 2003 $97,632.0
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54 Computron's Balance Sheets
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56 2002 2003
57 Assets
58 Cash and equivalents $9,000 $7,282
59 Short-term investments $48,600 $20,000
60 Accounts receivable $351,200 $632,160
61 Inventories $715,200 $1,287,360
62 Total current assets $1,124,000 $1,946,802
63 Gross fixed assets $491,000 $1,202,950
64 Less: Accumulated depreciation $146,200 $263,160
65 Net plant and equipment $344,800 $939,790
66 Total assets $1,468,800 $2,886,592
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68 Liabilities and equity
69 Accounts payable $145,600 $324,000
70 Notes payable $200,000 $720,000
71 Accruals $136,000 $284,960
72 Total current liabilities $481,600 $1,328,960
73 Long-term bonds $323,432 $1,000,000
74 Common Stock $460,000 $460,000
75 Retained Earnings $203,768 $97,632
76 Total Equity $663,768 $557,632
77 Total Liabilites and Equity $1,468,800 $2,886,592
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79 a. (2.) What effect did the expansion have on the asset side of the balance sheet? Answer: See Chapter 6 Mini Case Show
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81 Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is
82 shown below for Computron.
83 Computron's Statement of Cash Flows
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85 2003
 A B C D E F G H
86 Operating Activities
87 Net Income before preferred dividends ($95,136)
88 Noncash adjustments
89 Depreciation and amortization $116,960
90 Due to changes in working capital
91 Change in accounts receivable ($280,960)
92 Change in inventories ($572,160)
93 Change in accounts payable $178,400
94 Change in accruals $148,960
95 Net cash provided by operating activities ($503,936)
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97 Long-term investing activities
98 Cash used to acquire fixed assets ($711,950)
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100 Financing Activities
101 Change in short-term investments $28,600
102 Change in notes payable $520,000
103 Change in long-term debt $676,568
104 Payment of cash dividends ($11,000)
105 Net cash provided by financing activities $1,214,168
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107 Net change in cash and equivilents ($1,718)
108 Cash and securities at beginning of the year $9,000
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110 Cash and securities at end of the year $7,282
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113 b. What do you conclude from the statement of cash flows? Answer: See Chapter 6 Mini Case Show
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 A B C D E F G H
115 Summary Data Relating to Operating Performance and Cash Flows
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117 c. What are operating current assets? What are operating current liabilities? How much net operating working capital
118 and total net operating capital does Computron have?
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120 Net Operating Working Capital
121 Those current assets used in operations are called operating current assets, and the current liabilities that result from
122 operations are called operating current liabilities. Net operating working capital is equal to operating current assets minus
123 operating current liabilities.
124
Operating Operating
125 NOWC03 = current - current
assets liabilities
126 = $1,926,802 - $608,960
127 NOWC03 = $1,317,842
128
Operating Operating
129 NOWC02 = current - current
assets liabilities
130 = $1,075,400 - $281,600
131 NOWC02 = $793,800
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133 Total Net Operating Capital
134 The Total OperatingCapital is Net Operating Working Capital plus any fixed assets.
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136 TOC03 = NOWC + Fixed assets
137 = $1,317,842 + $939,790
138 TOC03 = $2,257,632
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140 TOC02 = NOWC + Fixed assets
141 = $793,800 + $344,800
142 TOC02 = $1,138,600
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144 d. What is free cash flow? Why is it important? What are the five uses of FCF? Answer: See Chapter 6 Mini Case Show
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146 e. What are Computron’s net operating profit after taxes (NOPAT) and free cash flow (FCF)?
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148 Net Operating Profit After Taxes
149 NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets.
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151 NOPAT03 = EBIT x (1-T)
152 = $17,440 x 60%
153 NOPAT03 = $10,464
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155 NOPAT02 = EBIT x (1-T)
156 = $209,100 x 60%
157 NOPAT02 = $125,460
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159 Free Cash Flow
160 Computron's Free Cash Flow caluclation is the cash flow actually availabe for distribution to investors after the company
161 has made all necessary investments in fixed assets and working capital to sustain ongoing operations.
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163 FCF03 = NOPAT - Net Investment in Operating Capital
164 = $10,464.0 - $1,119,032
165 FCF03 = -$1,108,568
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167 f. Calculate Computron’s return on invested capital. Computron has a 10% cost of capital (WACC). Do you think
168 Computron’s growth added value?
169 2002 2003
170 Cost of Capital (WACC) 10% 10%
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173 Return on Invested Capital
174 The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.
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176 ROIC03 = NOPAT ÷ Operating Capital
 A B C D E F G H
177 $10,464.0 $2,257,632
178 ROIC03 = 0.5%
179
180 ROIC02 = NOPAT ÷ Operating Capital
181 $125,460.0 $1,138,600
182 ROIC02 = 11.0%
183
184 g. What is Computron's EVA? The after-tax cost of capital was 10 percent in both years.
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186
187 Economic Value Added
188 Economic Value Added represents Computron's residual income that remains after the cost of all capital, including equity
189 capital, has been deducted.
190
191 EVA03 = NOPAT - Operating Capital x WACC
192 = $10,464 - $2,257,632 x 10%
193 = $10,464 - $225,763.2
194 EVA03 = -$215,299
195
196 EVA02 = NOPAT - Operating Capital x WACC
197 = $125,460 - $1,138,600 x 10%
198 = $125,460 - $113,860.0
199 EVA02 = $11,600
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201 h. What happened to Computron's market value added (MVA)?
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203 Year-end common stock price $8.50 $6.00
204 Year-end shares outstanding (in millions) 100,000 100,000
205 Earnings per share (EPS) ($0.95) $0.88
206 Dividends per share (DPS) $0.11 $0.22
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208 Market Value Added
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210 Assume that the market value of debt is equal to the book value of debt. In this case, Market Value Added (MVA) is the
211 difference between the market value of Computron's stock and the amount of equity capital supplied by shareholders.
212
213 MVA03 = Stock price x # of shares - Total common equity
214 = $6.00 x 100,000 - $557,632
215 = $600,000 - $557,632
216 MVA03 = $42,368
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218 MVA02 = Stock price x # of shares - Total common equity
219 = $8.50 x 100,000 - $663,768
220 = $850,000 - $663,768
221 MVA02 = $186,232
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223 This spreadsheet model should have either refreshed your memory of or introduced you to spreadsheet models. Go to the
224 TAXES model by clicking on the tab in the lower section of the screen.
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The Federal Income Tax System

This worksheet explores the calculation of corporate income taxes under the federal tax system. By using special Excel
functions, we can input a corporate tax schedule into a spreadsheet and then have a cell automatically display a company's tax
liability. Either of two procedures can be used, the IF function or the VLOOKUP function. Both functions are explained
below, using the data shown in the following tax table.

LOOKUP
There are actually two lookup functions, VLOOKUP for looking up items in vertical columns, and HLOOKUP for looking up
things in horizontal rows. Since our tax table is arranged in columns, we use VLOOKUP.

In words, Excel first looks down Column 1 (or A) and finds the largest value that does not exceed the firm's taxable income.
Next, it looks for the corresponding value in Column 3 (or C), which is the base amount of the tax. Then, it again looks down
Column (1) and finds the corresponding marginal tax rate as shown in Column 4. Then it multiplies the tax rate times the
difference between the firm's taxable income and the bottom tax bracket to get the incremental tax. Then it adds the base tax to
the incremental tax to get the firm's total tax liability.

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= $3,000
Begin by highlighting the range A33:D40, which
Taxable Inco $108,000 contains the tax table. Then click on the inverted
triangle at the left of the 4th row (the formula bar)
Corporate Tax Rates for 2001 and type the word "taxtable" to name the range.

If a corporation's It pays this Plus this percentage

taxable income amount on the on the excess Then put the pointer on E43, and then click the
is between: base of the bracketover the base function wizard, fx, select "Lookup & Reference," and
then select VLOOKUP. You will then get a menu box
(1) (2) (3) (4) like the one shown on the right of Column j (ours is
$0 $50,000 $0 15.0% filled in). When you fill in the menu box, and click
$50,000 $75,000 $7,500 25.0% OK, you will get this equation on the formula bar and
$75,000 $100,000 $13,750 34.0% $3,400,000 in cell C38. =VLOOKUP(C25,taxtable,3)
$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%
Next, put the pointer on E44, get the
$18,333,333 and up $6,416,667 35.0% VLOOKUP menu box, and look up the
marginal tax rate. The correct value is
35%, and here is the formula:
1st VLOOKUP to find the base amount of tax: $ 22,250 =VLOOKUP(C25,taxtable,4)
2nd VLOOKUP to find the marginal tax rate: 39.0%
3rd VLOOKUP to find the marginal income to be taxed: $ 8,000 3,120.0
Next, put the pointer on E45 and look up the marginal
tax bracket and then subtract it from the firm's
Total tax liability: $25,370 income to find the incremental income. Here is the
formula: =C25-VLOOKUP(C25,taxtable,1)

Finish by adding the tax on the marginal income to the tax on the bracket base.

j. Working with Jamison has required you to put in a lot of overtime, so you have had very little time to spend on your private
finances. It's now April 1, and you have only two weeks left to file your income tax return. You have managed to get all the
information together that you will need to complete your return. Computron paid you a salary of $45,000, and you received
$3,000 in dividends from common stock that you own. You are single, so your personal exemption is $3,000, and your itemized
deductions are $7,100.
j. Working with Jamison has required you to put in a lot of overtime, so you have had very little time to spend on your private
finances. It's now April 1, and you have only two weeks left to file your income tax return. You have managed to get all the
information together that you will need to complete your return. Computron paid you a salary of $45,000, and you received
$3,000 in dividends from common stock that you own. You are single, so your personal exemption is $3,000, and your itemized
deductions are $7,100.

(1.) On the basis of the information above and the individual tax rate schedule shown in this chapter, what is your tax
liability ?

(2.) What are your marginal and average tax rates?

Individual Income Taxes

Individual Income Tax Rates for 2002

You pay this Plus this

amount on percentage on
Your Taxable Income
the base of the excess over
the bracket the base
(1) (2) (3) (4)
$0 $6,000 $0.00 10.0%
$6,000 $27,950 $600.00 15.0%
$27,950 $67,700 $3,892.50 27.0%
$67,700 $141,250 $14,625.00 30.0%
$141,250 $307,050 $36,690.00 35.0%
$307,050 and up $94,720.00 38.6%
Taxable Income

Salary $45,000
Dividends $3,000
Personal Exe ($3,000)
Deductions ($7,100)
Taxable Inco $37,900

1st VLOOKUP to find the base amount of tax: $3,892.50

2nd VLOOKUP to find the marginal tax ra 27.0%
3rd VLOOKUP to find the marginal income $9,950.00 $2,686.50

Tax Liability $6,579.00

k. Assume that after paying your personal income tax as calculated in Part j, 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 Exxon 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 Exxon bonds?

Taxable vs. Tax Exempt bonds

Exxon bonds at 10% vs. California muni bonds at 7%

Amount to inv $5,000

Exxon Yield 10%
California Yi 7%
Tax Rate 27.0%

Exxon = Yield * (Investment) - Yield * (Investment) * (Tax Rate)

Exxon = $365.00

California = Yield * (Investment) - 0

California = $350.00

Tax rate which you would be indifferent

Solve for T
Muni Yield = Corp Yield *(1-Tax rate)
Tax Rate = 30.00%