Computron Inc. is a 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. 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.
The company recently hired Jenny Cochran, a graduate of UC to assist the chairman of the board to turnaround the fortunes of the company. Cochran recommendations included doubling the plant capacity, opening new sales offices outside the home territory, and launching an expensive advertising campaign to boost cash flows and stock price. Cochran believes that undertaking of such capital budgeting projects would increase sales, net income, and free cash flows to boost the stock price.
The corporate tax rate is 40%.
The following financial statement and reports were made available by the finance department for analysis:
Computron’s Income Statement |
|
|
| 2019 | 2020 |
Net sales | 2,059,200 | 3,500,640 |
Cost of Goods Sold | 1,718,400 | 2,988,000 |
Other Expenses | 204,000 | 432,000 |
Depreciation and amortization | 11,340 | 70,176 |
Total Operating Costs | 1,933,740 | 3,490,176 |
Earnings before interest and taxes (EBIT) | 125,460 | 10,464 |
Less interest | 37,500 | 105,600 |
Pre-tax earnings | 87,960 | (95,136) |
Taxes (40%) | 35,184 | (38,054) |
Net Income | 52,776 | (57,082) |
Computron’s Balance Sheet |
|
|
Assets |
|
|
Cash and equivalents | 5,400 | 4,369 |
Short-term investments | 29,160 | 12,000 |
Accounts receivable | 210,720 | 379,296 |
Inventories | 429,120 | 772,416 |
Total current assets | 674,400 | 1,168,081 |
Gross fixed assets | 294,600 | 721,770 |
Less: Accumulated depreciation | 87,720 | 157,896 |
Net plant and equipment | 206,880 | 563,874 |
Total assets | 881,280 | 1,731,955 |
Liabilities and equity |
|
|
Accounts payable | 87,360 | 194,400 |
Notes payable | 120,000 | 432,000 |
Accruals | 81,600 | 170,976 |
Total current liabilities | 288,960 | 797,376 |
Long-term bonds | 194,059 | 600,000 |
Common Stock | 276,000 | 276,000 |
Retained Earnings | 122,261 | 58,579 |
Total Equity | 398,261 | 334,579 |
Total Liabilities and Equity | 881,280 | 1,731,955 |
a. Explain to the chairman of the board
three
properties of future cashflows that would likely help increase Computron’s value.
b. What is Computron’s net operating profit after taxes (NOPAT) for 2020?
c. Calculate Computron’s free cash flow for 2020 if net investment in total operating capital is $671,419.
d. Explain to the chairman of the board
five
uses of free cash flow to help maximize the value of the firm.
e. Explain Economic Value Added (EVA) and compute Computron’s EVA for 2020 if total net operating capital is $1,354,579? The company’s weighted average cost of capital (WACC) is 10.0%.
f. Calculate the following
profitability ratios
for Computron in 2020:
g.
i. Operating profit margin
ii. Return on assets (ROA)
iii. Return on equity (ROE)
iv. Basic Earning Power (BEP)
h. Calculate the following
asset management ratios
for Computron in 2020:
i. total assets turnover
ii. Days sales outstanding (DSO)
i. Calculate the following
liquidity and debt management ratios
for Computron in 2020:
iii. Current ratio
iv. Quick ratio
v. Debt-to-assets ratio
vi. Times-interest earned ratio
j. Given the following industry ratios for 2020, how do you evaluate the financial performance of Computron (
poor or
better
) and explain:
a. Operating profit margin | 7.20% |
b. Basic Earning Power | 15.60% |
c. ROE | 15.40% |
d. Return on Assets | 10.80% |
e. Total Assets turnover | 1.5 |
f. Days sales outstanding | 28.00 |
g. Current ratio | 2.50 |
h. Quick ratio | 1.90 |
i. Debt-to-assets ratio | 15% |
j. Times-interest-earned | 13.00 |
i. Computron has a negative free cash flow in 2020. The financial manager explains to the board that there is nothing wrong with value-adding growth, even if it causes negative free cash flows in the short-term. Using return on invested capital (ROIC) performance evaluation approach, determine whether Cochran’s recommendation is adding value. Total operating capital of the company is $1,354,579 and WACC is 10%.
