Dilli Bista, MBA is the financial manager
Dilli Bista, MBA is the financial manager for Computron Inc. a large public corporation specializing in software manufacturing. The company designs and develops software programs that allow users to create their own documents, apps, animations, and other media content. Despite a huge investment made last three years in fixed assets, the company’s sales revenue and profit margins have decreased over the years because of the Covid-19 pandemic and complaints of some parents about the effect of video games on their kids’ social life and academic performance. Dilli is analyzing the company’s financial statements and annual reports to determine the financial performance of the company for the year and see how the performance can be improved.
Dilli noticed that last year the company had $4 million in operating income (EBIT). The company had a depreciation expense of $1 million and an interest expense of $1 million. The company’s tax rate is 25%. The company has $14 million in operating current assets and $4 million in operating current liabilities and has $15 million in net plant and equipment. The company has after-tax cost of capital of 10%.
1. List four types of financial statements that the company’s annual report typically include. State three items that can be found in each of the financial statement of Computron Inc.
2. Determine Computron’s net income for the year. Show your calculations.
3. What was Computron’s net cash flow?
4. What was Computron’s net operating profit after taxes (NOPAT)?
5. Calculate net operating working capital and total net operating capital for the year.
6. Calculate Computron’s free cash flow for the year if net operating capital in the previous year was $24 million.
7. Explain to the chairman of the board five uses of free cash flow that can help maximize the value of the firm.
8. Explain Economic Value Added (EVA) and compute Computron’s EVA if total net operating capital is $25 million? The company’s after-tax cost of capital is 10.0%.
9. Compute and explain market value added (MVA) for Computron using the following information:
i. total number of shares outstanding is 2 million
ii. current stock price is $35 per share
iii. total common equity is $68.2 million
10. Calculate the company’s return on invested capital (ROIC). Do you think Computron’s growth added value?
Submit your answers in a Word document.
Financial Statements, Cash Flow, and Taxes
CHAPTER 2
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Topics in Chapter
Income statement
Balance sheet
Statement of cash flows
Free cash flow
Performance measures
Corporate taxes
Personal taxes
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Determinants of Intrinsic Value: Calculating FCF
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Computron Inc.
Computron expanded operations in 2019. Following slides show key information and financial statements to evaluate the expansions.
| 2018 | 2019 | |
| Stock price | $50.00 | $30.00 |
| Shares outstanding (millions) | 100 | 100 |
| Common dividends (millions) | $90 | $84 |
| Tax rate | 25% | 25% |
| Cost of capital (WACC) | 10.00% | 10.00% |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Income Statement (Millions of Dollars)
| 2018 | 2019 | |
| Sales | $ 5,500 | $ 6,000 |
| COGS | 4,300 | 4,800 |
| Deprec. | 290 | 320 |
| Other expenses | 350 | 420 |
| Tot. op. costs | $ 4,940 | $ 5,540 |
| EBIT | $ 560 | $ 460 |
| Int. expense | 68 | 108 |
| Pre-tax earnings | $ 492 | $ 352 |
| Taxes (25%) | 123 | 88 |
| Net income | $ 369 | $ 264 |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What happened to sales and net income?
Sales increased by $500 million (9% growth).
59% increase in interest payments.
Net income fell by $105 million.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Balance Sheet: Assets (Millions of Dollars)
| 2018 | 2019 | |
| Cash | $ 60 | $ 50 |
| S-T invest. | 100 | 10 |
| AR | 400 | 520 |
| Inventories | 620 | 820 |
| Total CA | $ 1,180 | $ 1,400 |
| Gross FA | $ 3,900 | $ 4,820 |
| Less: Depr. | 1,000 | 1,320 |
| Net FA | $ 2,900 | $ 3,500 |
| Total assets | $ 4,080 | $ 4,900 |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect of Expansion on Assets
Current assets and net fixed assets each grew by over 20%, much more than sales grew.
AR and inventory almost doubled.
Taking longer to collect
Unsold products (or unused raw materials) in warehouses
Cash and short-term investments fell.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Balance Sheet: Liabilities & Equity (Millions of Dollars)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What effect did the expansion have on liabilities & equity?
Debt increased to help finance the expansion.
The company didn’t issue any stock.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Statement of Cash Flows for 2019: Operating Activities (Millions of Dollars)
| Operating Activities | |
| Net Income | $ 264 |
| Adjustments: | |
| Depreciation | 320 |
| Change in AR | (120) |
| Change in inventories | (200) |
| Change in AP | 100 |
| Change in accruals | 40 |
| Net cash provided (used) by ops. | $ 404 |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Statement of Cash Flows: Investing Activities (Millions of Dollars)
| Investing Activities | |
| Cash used to acquire FA | $ (920) |
| Change in S-T invest. | 90 |
| Net cash prov. (used) by inv. act. | $ (830) |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Statement of Cash Flows: Financing Activities (Millions of Dollars)
| Financing Activities | 2020 |
| Change in notes payable | $ 200 |
| Change in long-term debt | 300 |
| Payment of cash dividends | (84) |
| Net cash provided (used) by fin. act. | $ 416 |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Statement of Cash Flows: Summary (Millions of Dollars)
| Net cash provided (used) by ops. | $ 404 |
| Net cash prov. (used) by inv. act. | (830) |
| Net cash prov. (used) by fin. act. | 416 |
| Net change in cash | (10) |
| Cash at beginning of year | 60 |
| Cash at end of year | $ 50 |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What can you conclude from the statement of cash flows?
Positive net CF from operations:
Dragged down by big net increase in working capital.
Negative net CF from investing:
Small increase due to selling ST investments
Bigger decrease due to large FA expenditures.
Net CF from financing:
Big increase in borrowing.
Even after borrowing, the cash account fell.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What is free cash flow (FCF)? Why is it important?
FCF is the amount of cash available from operations for distribution to all investors (including stockholders and debtholders) after making the necessary investments to support operations.
A company’s value depends on the amount of FCF it can generate.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What are the five uses of FCF?
1. Pay interest on debt.
2. Pay back principal on debt.
3. Pay dividends.
4. Buy back stock.
5. Buy nonoperating assets (e.g., marketable securities, investments in other companies, etc.)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Calculating Free Cash Flow in 5 Easy Steps
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Net Operating Profit after Taxes (NOPAT)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What are operating current assets?
Operating current assets are the CA needed to support operations.
Op CA include: cash, inventory, receivables.
Op CA exclude: short-term investments, because these are not a part of operations.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
What are operating current liabilities?
Operating current liabilities are the CL resulting as a normal part of operations.
Op CL include: accounts payable and accruals.
Op CL exclude: notes payable, because this is a source of financing, not a part of operations.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Net Operating Working Capital (NOWC)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Total net operating capital (also called operating capital)
Operating Capital= NOWC + Net fixed assets.
Operating Capital 2019: OpCap19 = $750 + $3,500 = $4,250.
Operating Capital 2018:
OpCap18 = $3,480.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Free Cash Flow (FCF) for 2019
FCF NOPAT – Net investment in operating capital
How do you suppose investors reacted?
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Uses of FCF
| After-tax interest payment | $81 |
| Reduction (increase) in debt | −$500 |
| Payment of dividends | $84 |
| Repurchase (Issue) stock | $0 |
| Purch. (Sale) of ST investments | −$90 |
| Total uses of FCF | −$425 |
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Operating Profitability (OP) Ratio
Operating profitability (the amount of operating profit generated by a dollar of sales) fell.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Capital Requirement (CR) Ratio
Capital requirements (the amount of operating capital required to generate a dollar of sales) went up, which means capital utilization worsened.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Return on Invested Capital (ROIC)
ROIC fell due to a decline in operating profitability and an increase in the operating capital required to generate a dollar of sales.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The firm’s cost of capital is 10%. Did the growth add value?
No. The ROIC of 8.1% is less than the WACC of 10%. Investors did not get the return they require.
Note: High growth usually causes negative FCF (due to investment in capital), but that’s ok if ROIC > WACC.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Economic Value Added (EVA)
WACC is weighted average cost of capital
EVA = NOPAT − (WACC)(Capital)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Economic Value Added (WACC 10% for both years)
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Market Value Added (MVA) (1 of 2)
MVA = Market Value of the Firm
− Book Value of the Firm
Mkt Value = (# shares)(Price)
+ Mkt Val of Debt
Book Value = Total common equity + Debt
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Market Value Added (MVA) (2 of 2)
If the market value of debt is close to the book value of debt, then MVA is:
MVA = Market value of equity
− book value of equity
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2019 MVA (Assume market value of debt book value of debt.)
Market Value of Equity 2019:
(100)($30.00) = $3,000.
Book Value of Equity 2019:
$2,910.
MVA19 = $3,000 − $2,910 = $90.
MVA18 =$5,000 − $2,730 = $2,270.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Corporate Taxes and the 2017 Tax Cut and Jobs Act
First major rewrite since 1986 Tax Reform Act.
Corporate tax code permanent until Congress passes new law.
21% flat rate on taxable income.
Replaced progressive rates.
Replaced 35% top marginal rate.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Interest and Dividend Income Received by Corporation
Interest income received:
21% flat rate.
Dividend income received:
Can exclude 50% from taxable income.
Remainder is taxed at 21%.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Cumulative Prior Operating Losses
Carry forward losses:
Applies to cumulative past operating losses.
Carry forward to offset future taxable income and taxes
Carry forward indefinitely (prior to TCJA was 20 years).
Carry back losses:
Not allowed in TCJA.
Prior to TCJA:
Carry back 2 years.
Received tax refund from previously paid taxes.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Dividends Paid and Interest Expenses
Dividend payments to shareholders:
Not deductible as expense.
Interest expenses:
Can deduct interest expenses if below limit:
30% of EBITDA for 2019, 2020, and 2021.
30% of EBIT thereafter.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Corporate Capital Gains and Losses
Capital gains arise when a company sells an asset for more than it paid for the asset.
Capital losses are the opposite: the company sells the asset for less than it paid.
Capital gains and losses are treated like other income or losses.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Foreign Profits and the TCJA (1 of 2)
Foreign profits:
Earned by overseas subsidiary of U.S. company.
Taxed at subsidiary’s legal residence (e.g., Ireland because it has favorable tax laws)
Prior to TCJA:
No U.S. taxes due if reinvested overseas:
New or expanded operations.
Financial assets such as deposits at foreign bank.
U.S. taxes due only if profits returned to parent.
© 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Foreign Profits and the TCJA (2 of 2)
Profits earned 2018 and after:
Collepals.com Plagiarism Free Papers
Are you looking for custom essay writing service or even dissertation writing services? Just request for our write my paper service, and we'll match you with the best essay writer in your subject! With an exceptional team of professional academic experts in a wide range of subjects, we can guarantee you an unrivaled quality of custom-written papers.
Get ZERO PLAGIARISM, HUMAN WRITTEN ESSAYS
Why Hire Collepals.com writers to do your paper?
Quality- We are experienced and have access to ample research materials.
We write plagiarism Free Content
Confidential- We never share or sell your personal information to third parties.
Support-Chat with us today! We are always waiting to answer all your questions.
All Rights Reserved Terms and Conditions
College pals.com Privacy Policy 2010-2018