# case study week 1

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

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

## 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 =

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