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Ch02 Mini Case

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0% found this document useful (0 votes)
38 views11 pages

Ch02 Mini Case

Uploaded by

Carl Garrett
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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11/20/2018

Chapter 2 Mini Case

Situation

Jenny Cochran, a graduate of The University of Tennessee 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 Balance Sheets (Millions of Dollars)


2018 2019
Assets
Cash and equivalents $ 60 $ 50
Short-term investments 100 10
Accounts receivable 400 520
Inventories 620 820
Total current assets $ 1,180 $ 1,400
Gross fixed assets $ 3,900 $ 4,820
Less: Accumulated depreciation 1,000 1,320
Net fixed assets $ 2,900 $ 3,500
Total assets $ 4,080 $ 4,900

Liabilities and equity


Accounts payable $ 300 $ 400
Notes payable 50 250
Accruals 200 240
Total current liabilities $ 550 $ 890
Long-term bonds 800 1,100
Total liabilities $ 1,350 $ 1,990
Common stock 1,000 1,000
Retained earnings 1,730 1,910
Total equity $ 2,730 $ 2,910
Total liabilities and equity $ 4,080 $ 4,900

Computron's Income Statement (Millions of Dollars)


2018 2019
Net sales $ 5,500 $ 6,000
Cost of goods sold (Excluding depr. & amort.) 4,300 4,800
Depreciation and amortizationa 290 320
Other operating expenses 350 420
Total operating costs $ 4,940 $ 5,540
Earnings before interest and taxes (EBIT) $ 560 $ 460
Less interest 68 108
Pre-tax earnings $ 492 $ 352
Taxes (25%) 123 88
Net Income $ 369 $ 264

Notes:
a
Computron has no amortization charges.

Other Data 2018 2019


Stock price $50.00 $30.00
Shares outstanding (millions) 100 100
Common dividends (millions) $90 $84
Tax rate 25% 25%
Weighted average cost of capital (WACC) 10.00% 10.00%
Computron's Statement of Cash Flows (Millions of Dollars)
2019
Operating Activities
Net Income before preferred dividends $ 264
Noncash adjustments
Depreciation and amortization 320
Due to changes in working capital
Change in accounts receivable (120)
Change in inventories (200)
Change in accounts payable 100
Change in accruals 40
Net cash provided by operating activities $ 404

Investing activities
Cash used to acquire fixed assets $ (920)
Change in short-term investments 90
Net cash provided by investing activities $ (830)

Financing Activities
Change in notes payable $ 200
Change in long-term debt 300
Payment of cash dividends (84)
Net cash provided by financing activities $ 416

Net change in cash and equivalents $ (10)


Cash and securities at beginning of the year 60
Cash and securities at end of the year $ 50

a. (1.) What
It increased theeffect
salesdid the expansion
by 500K which means have
thatonthesales
new and net income?
expansions Answer:
are proving SeeifMini
positive Case
we look Show.
solely on Net Sales. However, the Net Income decreased.
The reason this happened is because the interest and operating expenses with the expansions increased significantly so it didn't actually increase the Net Income o
Freenet
The Cash Flowiniscash
change the cash
and available for investors after the company ishas used the necessary amounts on
stillits own operation and of
investment needs.
a.
Free(2.) What
It increased
cash the
flow effect did
current
is so theequivalents
assets,
important expansion
largely
because
from
dueithave
to the
onbeginning
their
really the asset
AR and
shows
toside
the end
ifofinventory
the ofgoing
companythe negative.
balance
up.cash
has When However,
sheet?
in looking
general
the
at company
Answer:
the
which See assets,
total Mini
allows the
has
Casea positive
business
amount
Showultimately cash and securities.
tocash
keep going.
A large
it is alsoreason for the decline with the change is because the expansion in their PP&E. This shows in their investing activities under used to acquire fixed ass
The five increased
The amount usesofofcash because
FCF include:
left
of the gross fixed assets which would be connected to the doubling the plant capacity.
is not very much going in to the next year and would not be able to cover a fraction of their total operating expenses.
b.
They - Paying
Whatwould interest
do have
you concludeto debtholders
from the
to feel confident thatstatement of cash
their net sales would flows? Answer:
be good enoughSeetheMini
next Case Show.
year to help with the expenses so they end up with cash by the end.
The-change
Repaying debtholders
in cash this next year will also be telling if the new expansions are a good addition or not.
- Paying dividends to shareholders
c. What is free cash
- Repurchase flow?
of stock Why
from is it important? What are the five uses of FCF? Answer: See Mini Case Show.
shareholders
- Buying short-term investments or other nonoperating assets
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.

2019 NOPAT = EBIT x (1-T)


= $460 x 75%
= $345

2018 NOPAT = EBIT x (1-T)


= $560 x 75%
= $420

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.

Operating Operating
2019 NOWC = current assets
− current
= $1,390 − liabilities
$640
= $750

Operating Operating
2018 NOWC = current assets
− current
= $1,080 − liabilities
$500
= $580

Total Net Operating Capital (TNOC)

TNOC = NOWC + net operating long-term assets

2019 TNOC = NOWC + Fixed assets


= $750 + $3,500
= $4,250

2018 TNOC = NOWC + Fixed assets


= $580 + $2,900
= $3,480

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 calculation 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.

2019 FCF = NOPAT − Net Investment in Operating Capital


= $345.0 − $770
= -$425

Uses of FCF 2019


After-tax interest payment = $81
Reduction (increase) in debt = -$500
Payment of dividends = $84
Repurchase (Issue) stock = $0
Purchase (Sale) of short-term investments = -$90
Total uses of FCF = -$425

f. Calculate Computron’s return on invested capital (ROIC). Computron has a 10% cost of capital (WACC). What caused the decline
in the ROIC? Was it due to operating profitability or capital utilization? Do you think Computron’s growth added value?

Return on Invested Capital


The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.

2019 ROIC = NOPAT ÷ Operating Capital


= $345.0 $4,250
= 8.1%

2018 ROIC = NOPAT ÷ Operating Capital


= $420.0 $3,480
= 12.1%

Operating Profitability
The operating profitability (OP) ratio shows how many dollars of operating profit are generated by each dollar of sales.

2019 OP = NOPAT ÷ Sales


= $345.0 $6,000
= 5.8%

2018 OP = NOPAT ÷ Sales


= $420.0 $6,000
= 7.0%
Capital Utilization
The capital utilization (CR) ratio shows how many dollars of operating assets are needed to generated a dollar of sales.

2019 CR = Total Op. Cap. ÷ Sales


= $4,250.0 $6,000
= 70.8%

2018 CR = Total Op. Cap. ÷ Sales


= $3,480.0 $6,000
= 58.0%

Operating profitability declined and the capital utlization worsened, each contributing to the big decrease in ROIC.

g. What is Computron's EVA? The cost of capital was 10% 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.

2019 EVA = NOPAT − Operating Capital x WACC


= $345 − $4,250 x 10%
= $345 − $425.0
= -$80

2018 EVA = NOPAT − Operating Capital x WACC


= $420 − $3,480 x 10%
= $420 − $348.0
= $72

h. What happened to Computron's market value added (MVA)?

Year-end common stock price $50.00 $30.00


Year-end shares outstanding (in millions) 100 100

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.

2019 MVA = Stock price x # of shares - Total common equity


= $30.00 x 100 - $2,910
= $3,000 - $2,910
= $90
2018
MVA = Stock price x # of shares - Total common equity
= $50.00 x 100 - $2,730
= $5,000 - $2,730
= $2,270

i. The Tax Cut and Jobs Act was signed into law in 2017. Briefly describe its key provisions related to corporate tax taxation.
Answer: See Mini Case Show.
Previously corporate tax rates were progressive. With the change, it is just a flat 21% to all taxable income.
The law also changed how interest expense is deducted. Previously it was fully deductible but after the act for the years 2018-2021 it reduced the

j. Assume that a corporation has $87 million of taxable income from operations. It also received interest income of $8 million and
dividend income of $10 million. The federal tax rate is 21% and the dividend exclusion rate is 50%. What is the company's
federal tax liability?

Operating income = $87 million


Interest income received = $8 million
Dividend income received = $10 million
Federal tax rate = 21%
Dividend exclusion rate = 50%

Taxable dividends= $5 million


Taxable income = $100 million

Federal corporate tax liability = $21 million

k. The Tax Cut and Jobs Act was signed into law in 2017. Briefly describe its key provisions related to personal taxation. Answer:
See Mini Case Show.

the key differences from before and after the act was passed are the different tax rates for the progressive brackets as well as different amounts f
l. Assume that you are in the 25% marginal tax bracket and that you have $20,000 to invest. You have narrowed your investment
choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one should you choose
and why? At what marginal tax rate would you be indifferent?

Taxable vs. Tax Exempt bonds

Amount to invest $20,000


Corporate interest rate 10%
Municipal interest rate 7%
Tax Rate 25.0%

After-tax interest

Corporate = Pre-tax interest - tax on interest


= Interest rate)(amount invested) - (tax rate)(pre-tax interest)
= $1,500.00

Muni = Pre-tax interest


= (Interest rate)(amount invested)
= $1,400.00 There is no tax on the muni

Tax rate at which you would be indifferent

After-tax yield on muni versus corp bond


Muni Yield = Corp Yield *(1-Tax rate)

Solve for T
Tax rate = 1 - (Muni yield / Corp yield)
Tax Rate = 30.00%
et Income decreased.
y increase the Net Income overall.
estment
cash needs.
and securities.
keep going.
sh used to acquire fixed assets.
enses.
th cash by the end.
2018-2021 it reduced the allowable interest expense to 30% of EBITA and after 2021 to 30% of EBIT
ell as different amounts for each tax bracket

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