7 Jenny Cochran, a graduate of The University of Tennessee with 4 years of experience as an equities analyst, was recently brought in as 8 assistant to the chairman of the board of Computron Industries, a manufacturer of computer components. 9 10 During the previous year, Computron had doubled its plant capacity, opened new sales offices outside its home territory, and launched 11 an expensive advertising campaign. Cochran was assigned to evaluate the impact of the changes. She began by gathering financial 12 statements and other data. 13 14 Computron's Balance Sheets (Millions of Dollars) 15 2018 2019 16 Assets 17 Cash and equivalents $ 60 $ 50 18 Short-term investments 100 10 19 Accounts receivable 400 520 20 Inventories 620 820 21 Total current assets $ 1,180 $ 1,400 22 Gross fixed assets $3,900 $ 4,820 23 Less: Accumulated depreciation 1,000 1,320 24 Net fixed assets $ 2,900 $ 3,500 25 Total assets $ 4,080 $ 4,900 26 27 Liabilities and equity 28 Accounts payable $ 300 $ 400 29 Notes payable 50 250 30 Accruals 200 240 31 Total current liabilities $ 550 $ 890 32 Long-term bonds 800 1,100 33 Total liabilities $ 1,350 $ 1,990 34 Common stock 1,000 1,000 35 Retained earnings 1,730 1,910 36 Total equity $ 2,730 $ 2,910 37 Total liabilities and equity $ 4,080 $ 4,900 38 39 40 Computron's Income Statement (Millions of Dollars) 41 2018 2019 42 Net sales $ 5,500 $ 6,000 43 Cost of goods sold (Excluding depr. & amort.) 4,300 4,800 44 Depreciation and amortization 290 320 45 Other operating expenses 350 420 46 Total operating costs $ 4,940 $ 5,540 47 Earnings before interest and taxes (EBIT) $ 560 $ 460 48 Less interest 68 108 49 Pre-tax earnings $ 492 $ 352 50 Taxes (25%) 123 88 Mini Case B E $ $ 108 352 88 264 $ 2019 $30.00 100 $84 25% 10.00% 2019 $ 264 320 D 48 Less interest 68 49 Pre-tax earnings 492 50 Taxes (25%) 123 51 Net Income $ 369 52 53 Notes: 54 Computron has no amortization charges. 55 56 Other Data 2018 57 Stock price $50.00 58 Shares outstanding (millions) 100 59 Common dividends (millions) $90 60 Tax rate 25% 61 Weighted average cost of capital (WACC) 10.00% 62 63 64 Computron's Statement of Cash Flows (Millions of Dollars) 65 66 Operating Activities 67 Net Income before preferred dividends 68 Noncash adjustments 69 Depreciation and amortization 70 Due to changes in working capital 71 Change in accounts receivable 72 Change in inventories 73 Change in accounts payable 74 Change in accruals 75 Net cash provided by operating activities 76 77 Investing activities 78 Cash used to acquire fixed assets 79 Change in short-term investments 80 Net cash provided by investing activities 81 82 Financing Activities 83 Change in notes payable 84 Change in long-term debt 85 Payment of cash dividends 86 Net cash provided by financing activities 87 88 Net change in cash and equivalents 89 Cash and securities at beginning of the year 90 Cash and securities at end of the year 91 Mini Case (120) (200) 100 40 $ 404 $ (920) 90 $ (830) $ 200 300 (84) $ 416 $ (10) 60 $ 50 B E F G H 94 D 93 a. (1.) What effect did the expansion have on sales and net income? (2 pts) 95 a. (2.) What effect did the expansion have on the asset side of the balance sheet? (2 pts) 96 97 b. What do you conclude from the statement of cash flows? (2 pts) 99 c. What is free cash flow? Why is it important? What are the five uses of FCF? (2 pts) 98 X IIIIII 100 101 d. What is Computron's net operating profit after taxes (NOPAT)? What are operating current assets? What are operating current 102 liabilities? How much net operating working capital and total net operating capital does Computron have? (7 pts) 103 104 Net Operating Profit After Taxes 105 106 NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets. 107 108 2019 NOPAT = EBIT (1-1) 109 110 111 112 2018 NOPAT = EBIT (1-1) 113 114 115 116 117 Net Operating Working Capital 118 119 Those current assets used in operations are called operating current assets, and the current liabilities that result from operations are 120 called operating current liabilities. Net operating working capital is equal to operating current assets minus operating current 121 liabilities. 122 Operating Operating current 123 2019 NOWC = current assets liabilities 124 125 126 Operating Operating 127 2018 NOWC = liabilities 128 129 130 Mini Case current current assets D H. + + + + A B E F G 130 131 Total Net Operating Capital (TNOC) 132 133 TNOC = NOWC + net operating long-term assets 134 135 2019 TNOC = NOWC Fixed assets 136 137 138 139 2018 TNOC = NOWC Fixed assets 140 141 142 143 e. What is Computron's free cash flow (FCF)? What are Computron's "net uses" of its FCF? (4pts) 144 145 Free Cash Flow 146 Computron's Free Cash Flow calculation is the cash flow actually availabe for distribution to investors after the company has made all 147 necessary investments in fixed assets and working capital to sustain ongoing operations. 148 149 2019 FCF = NOPAT Net Investment in Operating Capital 150 151 152 153 Uses of FCF 2019 154 After-tax interest payment = 155 Reduction (increase) in debt = 156 Payment of dividends = 157 Repurchase (Issue) stock = 158 Purchase (Sale) of short-term investments = 159 Total uses of FCF = 160 161 162 f. Calculate Computron's return on invested capital (ROIC). Computron has a 10% cost of capital (WACC). What caused the decline in the 163 ROIC? Was it due to operating profitability or capital utilization? Do you think Computron's growth added value? (6pts) 164 165 Return on Invested Capital 166 The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital. 167 168 2019 ROIC = NOPAT : Operating Capital 169 170 171 172 ROIC = NOPAT Oneratino ranital Mini Case = 2018 : : 172 2018 ROIC = NOPAT Operating Capital 173 174 175 176 Operating Profitability 177 The operating profitability (OP) ratio shows how many dollars of operating profit are generated by each dollar of sales. 178 179 2019 OP = NOPAT Sales 180 181 182 183 2018 OP = NOPAT Sales 184 185 186 187 Capital Utilization 188 The capital utilization (CR) ratio shows how many dollars of operating assets are needed to generated a dollar of sales. 189 190 2019 CR= Total Op. Cap. Sales 191 192 193 194 2018 CR= Total Op. Cap. Sales 195 196 197 198 Operating profitability declined and the capital utlization worsened, each contributing to the big decrease in ROIC. : : II II II 199 200 g. What is Computron's EVA? The cost of capital was 10% in both years. (4pts) 201 202 Economic Value Added 203 Economic Value Added represents Computron's residual income that remains after the cost of all capital, including equity capital, has 204 been deducted. 205 206 2019 EVA = NOPAT Operating Capital WACC 207 208 209 210 2018 EVA = NOPAT Operating Capital WACC 211 212 213 Mini Case = X X 214 h. What happened to Computron's market value added (MVA)? (2pts) 215 216 Year-end common stock price $50.00 $30.00 217 Year-end shares outstanding (in millions) 100 100 218 219 Market Value Added 220 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 221 between the market value of Computron's stock and the amount of equity capital supplied by shareholders. 222 223 2019 MVA = Stock price # of shares Total common equity 224 225 226 2018 227 MVA = Stock price # of shares Total common equity 228 229 230 231 232 233 i. Assume that a corporation has $87 million of taxable income from operations. It also received interest income of $8 million and 234 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 235 liability? (2pts) 236 237 Operating income = $87 million 238 Interest income received = $8 million 239 Dividend income received = $10 million 240 Federal tax rate = 21% 241 Dividend exclusion rate = 50% 242 243 Taxable dividends million 244 Taxable income = million 245 246 Federal corporate tax liability = million 247 248 249 250 j. Assume that you are in the 25% marginal tax bracket and that you have $20,000 to invest. You have narrowed your investment 251 choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one should you choose and 252 why? At what marginal tax rate would you be indifferent? (4 pts) 253 Mini Case 239 Dividend income received = $10 million 240 Federal tax rate = 21% 241 Dividend exclusion rate = 50% 242 243 Taxable dividends million 244 Taxable income million 245 246 Federal corporate tax liability million 247 248 249 250 j. Assume that you are in the 25% marginal tax bracket and that you have $20,000 to invest. You have narrowed your investment 251 choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one should you choose and 252 why? At what marginal tax rate would you be indifferent? (4 pts) 253 254 255 Taxable vs. Tax Exempt bonds 256 257 Amount to invest $20,000 258 Corporate interest rate 10% 259 Municipal interest rate 7% 260 Tax Rate 25.0% 261 262 After-tax interest 263 264 Corporate = Pre-tax interest - tax on interest 265 266 267 Muni = Pre-tax interest 268 There is no tax on the muni 269 270 Tax rate at which you would be indifferent 271 272 After-tax yield on muni versus corp bond 273 Muni Yield = Corp Yield *(1-Tax rate) 274 275 Solve for T 276 Tax rate = 1. (Muni yield /Corp yield) 277 Tax Rate = 278 279 280 Mini Case + 7 Jenny Cochran, a graduate of The University of Tennessee with 4 years of experience as an equities analyst, was recently brought in as 8 assistant to the chairman of the board of Computron Industries, a manufacturer of computer components. 9 10 During the previous year, Computron had doubled its plant capacity, opened new sales offices outside its home territory, and launched 11 an expensive advertising campaign. Cochran was assigned to evaluate the impact of the changes. She began by gathering financial 12 statements and other data. 13 14 Computron's Balance Sheets (Millions of Dollars) 15 2018 2019 16 Assets 17 Cash and equivalents $ 60 $ 50 18 Short-term investments 100 10 19 Accounts receivable 400 520 20 Inventories 620 820 21 Total current assets $ 1,180 $ 1,400 22 Gross fixed assets $3,900 $ 4,820 23 Less: Accumulated depreciation 1,000 1,320 24 Net fixed assets $ 2,900 $ 3,500 25 Total assets $ 4,080 $ 4,900 26 27 Liabilities and equity 28 Accounts payable $ 300 $ 400 29 Notes payable 50 250 30 Accruals 200 240 31 Total current liabilities $ 550 $ 890 32 Long-term bonds 800 1,100 33 Total liabilities $ 1,350 $ 1,990 34 Common stock 1,000 1,000 35 Retained earnings 1,730 1,910 36 Total equity $ 2,730 $ 2,910 37 Total liabilities and equity $ 4,080 $ 4,900 38 39 40 Computron's Income Statement (Millions of Dollars) 41 2018 2019 42 Net sales $ 5,500 $ 6,000 43 Cost of goods sold (Excluding depr. & amort.) 4,300 4,800 44 Depreciation and amortization 290 320 45 Other operating expenses 350 420 46 Total operating costs $ 4,940 $ 5,540 47 Earnings before interest and taxes (EBIT) $ 560 $ 460 48 Less interest 68 108 49 Pre-tax earnings $ 492 $ 352 50 Taxes (25%) 123 88 Mini Case B E $ $ 108 352 88 264 $ 2019 $30.00 100 $84 25% 10.00% 2019 $ 264 320 D 48 Less interest 68 49 Pre-tax earnings 492 50 Taxes (25%) 123 51 Net Income $ 369 52 53 Notes: 54 Computron has no amortization charges. 55 56 Other Data 2018 57 Stock price $50.00 58 Shares outstanding (millions) 100 59 Common dividends (millions) $90 60 Tax rate 25% 61 Weighted average cost of capital (WACC) 10.00% 62 63 64 Computron's Statement of Cash Flows (Millions of Dollars) 65 66 Operating Activities 67 Net Income before preferred dividends 68 Noncash adjustments 69 Depreciation and amortization 70 Due to changes in working capital 71 Change in accounts receivable 72 Change in inventories 73 Change in accounts payable 74 Change in accruals 75 Net cash provided by operating activities 76 77 Investing activities 78 Cash used to acquire fixed assets 79 Change in short-term investments 80 Net cash provided by investing activities 81 82 Financing Activities 83 Change in notes payable 84 Change in long-term debt 85 Payment of cash dividends 86 Net cash provided by financing activities 87 88 Net change in cash and equivalents 89 Cash and securities at beginning of the year 90 Cash and securities at end of the year 91 Mini Case (120) (200) 100 40 $ 404 $ (920) 90 $ (830) $ 200 300 (84) $ 416 $ (10) 60 $ 50 B E F G H 94 D 93 a. (1.) What effect did the expansion have on sales and net income? (2 pts) 95 a. (2.) What effect did the expansion have on the asset side of the balance sheet? (2 pts) 96 97 b. What do you conclude from the statement of cash flows? (2 pts) 99 c. What is free cash flow? Why is it important? What are the five uses of FCF? (2 pts) 98 X IIIIII 100 101 d. What is Computron's net operating profit after taxes (NOPAT)? What are operating current assets? What are operating current 102 liabilities? How much net operating working capital and total net operating capital does Computron have? (7 pts) 103 104 Net Operating Profit After Taxes 105 106 NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets. 107 108 2019 NOPAT = EBIT (1-1) 109 110 111 112 2018 NOPAT = EBIT (1-1) 113 114 115 116 117 Net Operating Working Capital 118 119 Those current assets used in operations are called operating current assets, and the current liabilities that result from operations are 120 called operating current liabilities. Net operating working capital is equal to operating current assets minus operating current 121 liabilities. 122 Operating Operating current 123 2019 NOWC = current assets liabilities 124 125 126 Operating Operating 127 2018 NOWC = liabilities 128 129 130 Mini Case current current assets D H. + + + + A B E F G 130 131 Total Net Operating Capital (TNOC) 132 133 TNOC = NOWC + net operating long-term assets 134 135 2019 TNOC = NOWC Fixed assets 136 137 138 139 2018 TNOC = NOWC Fixed assets 140 141 142 143 e. What is Computron's free cash flow (FCF)? What are Computron's "net uses" of its FCF? (4pts) 144 145 Free Cash Flow 146 Computron's Free Cash Flow calculation is the cash flow actually availabe for distribution to investors after the company has made all 147 necessary investments in fixed assets and working capital to sustain ongoing operations. 148 149 2019 FCF = NOPAT Net Investment in Operating Capital 150 151 152 153 Uses of FCF 2019 154 After-tax interest payment = 155 Reduction (increase) in debt = 156 Payment of dividends = 157 Repurchase (Issue) stock = 158 Purchase (Sale) of short-term investments = 159 Total uses of FCF = 160 161 162 f. Calculate Computron's return on invested capital (ROIC). Computron has a 10% cost of capital (WACC). What caused the decline in the 163 ROIC? Was it due to operating profitability or capital utilization? Do you think Computron's growth added value? (6pts) 164 165 Return on Invested Capital 166 The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital. 167 168 2019 ROIC = NOPAT : Operating Capital 169 170 171 172 ROIC = NOPAT Oneratino ranital Mini Case = 2018 : : 172 2018 ROIC = NOPAT Operating Capital 173 174 175 176 Operating Profitability 177 The operating profitability (OP) ratio shows how many dollars of operating profit are generated by each dollar of sales. 178 179 2019 OP = NOPAT Sales 180 181 182 183 2018 OP = NOPAT Sales 184 185 186 187 Capital Utilization 188 The capital utilization (CR) ratio shows how many dollars of operating assets are needed to generated a dollar of sales. 189 190 2019 CR= Total Op. Cap. Sales 191 192 193 194 2018 CR= Total Op. Cap. Sales 195 196 197 198 Operating profitability declined and the capital utlization worsened, each contributing to the big decrease in ROIC. : : II II II 199 200 g. What is Computron's EVA? The cost of capital was 10% in both years. (4pts) 201 202 Economic Value Added 203 Economic Value Added represents Computron's residual income that remains after the cost of all capital, including equity capital, has 204 been deducted. 205 206 2019 EVA = NOPAT Operating Capital WACC 207 208 209 210 2018 EVA = NOPAT Operating Capital WACC 211 212 213 Mini Case = X X 214 h. What happened to Computron's market value added (MVA)? (2pts) 215 216 Year-end common stock price $50.00 $30.00 217 Year-end shares outstanding (in millions) 100 100 218 219 Market Value Added 220 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 221 between the market value of Computron's stock and the amount of equity capital supplied by shareholders. 222 223 2019 MVA = Stock price # of shares Total common equity 224 225 226 2018 227 MVA = Stock price # of shares Total common equity 228 229 230 231 232 233 i. Assume that a corporation has $87 million of taxable income from operations. It also received interest income of $8 million and 234 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 235 liability? (2pts) 236 237 Operating income = $87 million 238 Interest income received = $8 million 239 Dividend income received = $10 million 240 Federal tax rate = 21% 241 Dividend exclusion rate = 50% 242 243 Taxable dividends million 244 Taxable income = million 245 246 Federal corporate tax liability = million 247 248 249 250 j. Assume that you are in the 25% marginal tax bracket and that you have $20,000 to invest. You have narrowed your investment 251 choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one should you choose and 252 why? At what marginal tax rate would you be indifferent? (4 pts) 253 Mini Case 239 Dividend income received = $10 million 240 Federal tax rate = 21% 241 Dividend exclusion rate = 50% 242 243 Taxable dividends million 244 Taxable income million 245 246 Federal corporate tax liability million 247 248 249 250 j. Assume that you are in the 25% marginal tax bracket and that you have $20,000 to invest. You have narrowed your investment 251 choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one should you choose and 252 why? At what marginal tax rate would you be indifferent? (4 pts) 253 254 255 Taxable vs. Tax Exempt bonds 256 257 Amount to invest $20,000 258 Corporate interest rate 10% 259 Municipal interest rate 7% 260 Tax Rate 25.0% 261 262 After-tax interest 263 264 Corporate = Pre-tax interest - tax on interest 265 266 267 Muni = Pre-tax interest 268 There is no tax on the muni 269 270 Tax rate at which you would be indifferent 271 272 After-tax yield on muni versus corp bond 273 Muni Yield = Corp Yield *(1-Tax rate) 274 275 Solve for T 276 Tax rate = 1. (Muni yield /Corp yield) 277 Tax Rate = 278 279 280 Mini Case +