Week 1 case study 1

Outcome Alignment

Program Outcome

Course Outcome

1. Students will apply best practices to solve managerial issues.

Students will apply corporate financial management concepts

Task Description and

Instructions

Overview

This is a case study to help you understand the financial statements and learn how to work with financial data in excel. You will use the following scenario:

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.

Instructions

Download and complete this Excel worksheet

for the case study and submit as an .xlsx or .xls file.

Please use Excel functions to show your answers so that your instructor can see your calculation details for full credit. 

Mini Case

perience 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.

term investments

0

10

0

0

50

1,000
1,000

$ 4,080
$ 4,900

2018
2019

320

350

)

)

2018
2019

s)

100
100

4

25%
25%

)

10.00%

2019

$ 264

320

100

40

Bart Kreps: The statement of cash flows provides information about cash inflows and outflows during an accounting period.

90

300

60

)? What are operating current assets? What are operating current liabilities? How much net operating working capital and total net operating capital does Computron have? (7 pts)

2019

EBIT
x

=

x

=

2018

EBIT
x
( 1 – T )

=

x

=

2019

=

=

−

=

2018
NOWC =
Operating current assets
−
Operating current liabilities

=

−

=

(TNOC)

net operating long-term assets

2019

NOWC
+

=

+

=

2018
TNOC =
NOWC
+
Fixed assets

=

+

=

2019

NOPAT
−

=

−

=

2019

payment =

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? (6pts)

2019

NOPAT

Operating Capital

=

=

2018
ROIC =
NOPAT
÷
Operating Capital

=

=

2019

NOPAT
÷

=

=

2018
OP =
NOPAT
÷
Sales

=

=

2019

÷
Sales

=

=

2018
CR =
Total Op. Cap.
÷
Sales

=

=

2019

NOPAT
−

WACC

=

−

x

=

2018

NOPAT
−
Operating Capital x

WACC

=

−

x

=

$50.00
$30.00

100
100

2019

Stock price
x

–

=

x

–

=

2018

MVA =
Stock price
x
# of shares
–
Total common equity

=

x

–

=

million of taxable income from operations. It also received interest income of $8 million and dividend income of

million. The federal tax rate is

and the dividend exclusion rate is

. What is the company’s federal tax liability? (2pts)

$87
million

$8
million

$10
million

21%

50%

million

million

million

to invest. You have narrowed your investment choices down to municipal bonds yielding

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? (4 pts)

$20,000

10%

7%

After-tax interest

– tax on interest

=

Pre-tax interest

=

11/20/18

Chapter 2 Mini Case

Situation

Jenny Cochran, a graduate of The University of Tennessee with 4 years of e

x

Computron’s Balance Sheets (Millions of Dollars)

2018

2019

Assets

Cash and equivalents

$

60

$

50

Short

–

10

Accounts receivable

40

520

Inventories

620

820

Total current assets

$ 1,180

$ 1,400

Gross fixed assets

$ 3,

90

$ 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

250

Accruals

200

240

Total current liabilities

$ 550

$ 890

Long-term bonds

800

1,

100

Total liabilities

$ 1,

350

$ 1,990

Common stock

Retained earnings

1,730

1,910

Total equity

$ 2,730

$ 2,910

Total liabilities and equity

Computron’s Income Statement (Millions of Dollars)

Net sales

$ 5,500

$ 6,000

Cost of goods sold (Excluding depr. & amort.)

4,300

4,800

Depreciation and amortizationa

290

Other operating expenses

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

Stock price

$50.00

$30.00

Shares outstanding (

million

Common dividends (millions)

$90

$8

Tax rate

Weighted average cost of capital (

WACC

10.00%

Computron’s Statement of Cash Flows (Millions of Dollars)

Bart Kreps: The statement of cash flows provides information about cash inflows and outflows during an accounting period.

Operating Activities

Net Income before preferred dividends

Noncash adjustments

Depreciation and amortization

Due to changes in working capital

Change in accounts receivable

(120)

Change in inventories

(200)

Change in accounts payable

Change in accruals

Net cash provided by operating activities

$ 404

Investing activities

Cash used to acquire fixed assets

$ (920) Bart Kreps: Make sure to add back annual Depreciation to Net PP&E.

Change in short-term investments

Net cash provided by investing activities

$ (830)

Financing Activities

Change in notes payable

$ 200

Change in long-term debt

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

Cash and securities at end of the year

$ 50

a. (1.) What effect did the expansion have on sales and net income? (2 pts)

a. (2.) What effect did the expansion have on the asset side of the balance sheet? (2 pts)

b. What do you conclude from the statement of cash flows? (2 pts)

c. What is free cash flow? Why is it important? What are the five uses of FCF? (2 pts)

d. What is Computron’s net operating profit after taxes (

NOPAT

Net Operating Profit After Taxes

NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets.

NOPAT

=

( 1 – T )

NOPAT =

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.

NOWC

Operating current assets

−

Operating current liabilities

Total Net

Operating Capital

TNOC = NOWC

+

TNOC =

Fixed assets

e. What is Computron’s free cash flow (FCF)? What are Computron’s “net uses” of its FCF? (4pts)

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.

FCF =

Net Investment in Operating Capital

Uses of FCF

After-tax interest

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 (ROIC). Computron has a

10%

Return on Invested Capital

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

ROIC =

÷

Operating Profitability

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

OP =

Sales

Capital Utilization

The capital utilization (CR) ratio shows how many dollars of operating assets are needed to generated a dollar of sales.

CR =

Total Op. Cap.

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. (4pts)

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.

EVA =

Operating Capital x

EVA =

h. What happened to Computron’s market value added (MVA)? (2pts)

Year-end common stock price

Year-end shares outstanding (in millions)

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.

MVA =

# of shares

Total common equity

i. Assume that a corporation has

$87

$10

21%

50%

Operating income =

Interest income received =

Dividend income received =

Federal tax rate =

Dividend exclusion rate =

Taxable dividends=

Taxable income =

Federal corporate tax liability =

j. Assume that you are in the 25% marginal tax bracket and that you have

$20,000

7%

Taxable vs. Tax Exempt bonds

Amount to invest

Corporate interest rate

Municipal interest rate

Tax Rate

25.0%

Corporate =

Pre-tax interest

Muni =

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 =