a. (1) On what financial goal does Stanley seem to be focusing? Is it the correct goal? Why or why not? (2) Could a potential agency problem exist in this firm? Explain. b. Calculate the firm's earnings per share (EPS) for each year, recognizing that the number of shares of common stock outstanding has re- mained unchanged since the firm's inception. Comment on the EPS performance in view of your response in part a. c. Use the financial data presented to determine Track's operating cash flow (OCF) and free cash flow (FCF) in 2015. Evaluate your find- ings in light of Track's current cash flow difficulties. d. Analyze the firm's financial condition in 2015 as it relates to (1) liquidity, (2) activity, (3) debt, (4) profitability, and (5) market, using the financial statements provided in Tables 2 and 3 and the ratio data included in Table 5. Be sure to evaluate the firm on both a cross- sectional and a time-series basis. e. What recommendation would you make to Stanley regarding hiring a new software de- veloper? Relate your recommendation here to your responses in part a. f. Track Software paid $5,000 in dividends in 2015. Suppose that an investor approached Stanley about buying 100% of his firm. If this investor believed that by owning the compa- ny he could extract $5,000 per year in cash f. Track Software paid $5,000 in dividends in 2015. Suppose that an investor approached Stanley about buying 100% of his firm. If this investor believed that by owning the compa- ny he could extract $5,000 per year in cash from the company in perpetuity, what do you think the investor would be willing to pay for the firm if the required return on this invest- ment is 10%? g. Suppose that you believed that the FCF gen- erated by Track Software in 2015 could con- tinue forever. You are willing to buy the com- pany in order to receive this perpetual stream of free cash flow. What are you willing to pay if you require a 10% return on your investment? Integrative Case 2 Track Software, Inc. Seven years ago, after 15 years in public account- ing, Stanley Booker, CPA, resigned his position as manager of cost systems for Davis, Cohen, and O'Brien Public Accountants and started Track Soft- ware, Inc. In the 2 years preceding his departure from Davis, Cohen, and O'Brien, Stanley had spent nights and weekends developing a sophisticated cost-accounting software program that became Track's initial product offering. As the firm grew, Stanley planned to develop and expand the soft- ware product offerings, all of which would be related to streamlining the accounting processes of medi- um- to large-sized manufacturers. Although Track experienced losses during its first 2 years of operation-2009 and 2010-its profit has increased steadily from 2011 to the present (2015). The firm's profit history, including dividend pay- ments and contributions to retained earnings, is summarized in Table 1. Stanley started the firm with a $100,000 investment: his savings of $50,000 as equity and a $50,000 long-term loan from the bank. He had hoped to maintain his initial 100 percent ownership in the cor- poration, but after experiencing a $50,000 loss dur- ing the first year of operation (2009), he sold 60 per- cent of the stock to a group of investors to obtain needed funds. Since then, no other stock transac- tions have taken place. Although he owns only 40 percent of the firm, Stanley actively manages all as- pects of its activities; the other stockholders are not pects of its activities; the other stockholders are not active in management of the firm. The firm's stock was valued at $4.50 per share in 2014 and at $5.28 per share in 2015. Table 1 Track Software, Inc., Profit, Dividends, and Retained Earnings, 2009-2015 Year Net prof- Divi- Contribution to re- its after dends tained earnings [(1) taxes (1) paid - (2)] (3) (2) ($50,000) (20,000) 2009 ($50,000 $0 2010 (20,000) 0 2011 15,000 10 2012 35,000 0 15,000 35,000 2013 40,000 1,000 39,000 2014 43,000 2015 48,000 3,000 5,000 40,000 43,000 Stanley has just prepared the firm's 2015 income statement, balance sheet, and statement of retained earnings, shown in Tables 2, 3, and 4, along with the 2014 balance sheet. In addition, he has compiled the 2014 ratio values and industry average ratio val- ues for 2015, which are applicable to both 2014 and 2015 and are summarized in Table 5. He is quite pleased to have achieved record earnings of $48,000 in 2015, but he is concerned about the firm's cash flows. Specifically, he is finding it more and more difficult to pay the firm's bills in a timely and more difficult to pay the firm's bills in a timely manner and generate cash flows to investors, both creditors and owners. To gain insight into these cash flow problems, Stanley is planning to deter- mine the firm's 2015 operating cash flow (OCF) and free cash flow (FCF). Stanley is further frustrated by the firm's inability to afford to hire a software developer to complete de- velopment of a cost estimation package that is be- lieved to have "blockbuster sales potential. Stanley began development of this package 2 years ago, but the firm's growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product. Stanley's reluctance to fill this position stems from his concern that the added $80,000 per year in salary and benefits for the position would certainly lower the firm's earnings per share (EPS) over the next couple of years. Although the project's success is in no way guaranteed, Stanley believes that if the money were spent to hire the software developer, the firm's sales and earnings would significantly rise once the 2- to 3-year development, production, and marketing process was completed. With all these concerns in mind, Stanley set out to review the various data to develop strategies that would help ensure a bright future for Track Soft- ware. Stanley believed that as part of this process, a thorough ratio analysis of the firm's 2015 results would provide important additional insights. Table 2 Track Software, Inc., Income Statement (S000) for the Year Ended December 31, 2015 Table 2 Track Software, Inc., Income Statement ($000) for the Year Ended December 31, 2015 Sales revenue $ 1,550 Less: Cost of goods sold $ 1.030 Gross profits $ 520 Less: Operating expenses Selling expense $ 150 General and administrative expenses 270 Depreciation expense 11 Total operating expense 431 Operating profits (EBIT) $ 89 Less: Interest expense Net profits before taxes 60 Less: Taxes (20%) 12 Net profits after taxes Table 3 Track Software, Inc., Balance Sheet ($000) Decem- ber 31 Assets 2015 2014 $12 $ 31 Cash Marketable securities Accounts receivable 152 104 Inventories 191 145 Total current assets $421 $362 $195 $180 Gross fixed assets Less: Accumulated depreciation 63 52 Net fixed assets $132 $128 Total assets $553 $490 Liabilities and stockholders' equity Accounts payable Notes payable $136 $126 200 190 27 25 $363 $341 Accruals Total current liabilities Long-term debt $ 38 S 40 Total liabilities $401 $381 Common stock (50,000 shares out- Liabilities and stockholders' equity Accounts payable $136 $126 Notes payable 200 190 Accruals 27 Total current liabilities 25 $363 $341 $ 38 $ 40 Long-term debt Total liabilities $401 $381 Common stock (50,000 shares out- $ 20 $ 20 standing at $0.40 par value) Paid-in capital in excess of par - 30 | 30 Retained earnings 10259 Total stockholders' equity $152 $109 Total liabilities and stockholders' eq- $553 $490 uity Table 4 Track Software, Inc., Statement of Re- tained Earnings ($000) for the Year Ended De- cember 31, 2015 $ 59 Retained earnings balance (January 1, 2015) Plus: Net profits after taxes (for 2015) - 48 1_5 Less: Cash dividends on common stock (paid during 2015) $102 Retained earnings balance (December 31, 2015) Table 5 Ratio Actual 2014 Industry aver- age 2015 1.82 Current ratio 1.06 Quick ratio 0.63 Inventory turnover 10.40 Average collection pe- 29.6 riod days 1.10 12.45 20.2 days Total asset turnover 2.66 3.92 Debt ratio 0.78 0.55 3.0 5.6 Times interest earned ratio Gross profit margin 3 2.1% 42.3% 5.5% 12.4% Operating profit mar- gin Net profit margin 3.0% 4.0% 8.0% 15.6% Return on total assets (ROA) 36.4% 34.7% Return on common equity (ROE) 5.2 7.1 Price/earnings (P/E) ratio 2.2 Market/book (M/B) ra- 2.1 tio a. (1) On what financial goal does Stanley seem to be focusing? Is it the correct goal? Why or why not? (2) Could a potential agency problem exist in this firm? Explain. b. Calculate the firm's earnings per share (EPS) for each year, recognizing that the number of shares of common stock outstanding has re- mained unchanged since the firm's inception. Comment on the EPS performance in view of your response in part a. c. Use the financial data presented to determine Track's operating cash flow (OCF) and free cash flow (FCF) in 2015. Evaluate your find- ings in light of Track's current cash flow difficulties. d. Analyze the firm's financial condition in 2015 as it relates to (1) liquidity, (2) activity, (3) debt, (4) profitability, and (5) market, using the financial statements provided in Tables 2 and 3 and the ratio data included in Table 5. Be sure to evaluate the firm on both a cross- sectional and a time-series basis. e. What recommendation would you make to Stanley regarding hiring a new software de- veloper? Relate your recommendation here to your responses in part a. f. Track Software paid $5,000 in dividends in 2015. Suppose that an investor approached Stanley about buying 100% of his firm. If this investor believed that by owning the compa- ny he could extract $5,000 per year in cash f. Track Software paid $5,000 in dividends in 2015. Suppose that an investor approached Stanley about buying 100% of his firm. If this investor believed that by owning the compa- ny he could extract $5,000 per year in cash from the company in perpetuity, what do you think the investor would be willing to pay for the firm if the required return on this invest- ment is 10%? g. Suppose that you believed that the FCF gen- erated by Track Software in 2015 could con- tinue forever. You are willing to buy the com- pany in order to receive this perpetual stream of free cash flow. What are you willing to pay if you require a 10% return on your investment? Integrative Case 2 Track Software, Inc. Seven years ago, after 15 years in public account- ing, Stanley Booker, CPA, resigned his position as manager of cost systems for Davis, Cohen, and O'Brien Public Accountants and started Track Soft- ware, Inc. In the 2 years preceding his departure from Davis, Cohen, and O'Brien, Stanley had spent nights and weekends developing a sophisticated cost-accounting software program that became Track's initial product offering. As the firm grew, Stanley planned to develop and expand the soft- ware product offerings, all of which would be related to streamlining the accounting processes of medi- um- to large-sized manufacturers. Although Track experienced losses during its first 2 years of operation-2009 and 2010-its profit has increased steadily from 2011 to the present (2015). The firm's profit history, including dividend pay- ments and contributions to retained earnings, is summarized in Table 1. Stanley started the firm with a $100,000 investment: his savings of $50,000 as equity and a $50,000 long-term loan from the bank. He had hoped to maintain his initial 100 percent ownership in the cor- poration, but after experiencing a $50,000 loss dur- ing the first year of operation (2009), he sold 60 per- cent of the stock to a group of investors to obtain needed funds. Since then, no other stock transac- tions have taken place. Although he owns only 40 percent of the firm, Stanley actively manages all as- pects of its activities; the other stockholders are not pects of its activities; the other stockholders are not active in management of the firm. The firm's stock was valued at $4.50 per share in 2014 and at $5.28 per share in 2015. Table 1 Track Software, Inc., Profit, Dividends, and Retained Earnings, 2009-2015 Year Net prof- Divi- Contribution to re- its after dends tained earnings [(1) taxes (1) paid - (2)] (3) (2) ($50,000) (20,000) 2009 ($50,000 $0 2010 (20,000) 0 2011 15,000 10 2012 35,000 0 15,000 35,000 2013 40,000 1,000 39,000 2014 43,000 2015 48,000 3,000 5,000 40,000 43,000 Stanley has just prepared the firm's 2015 income statement, balance sheet, and statement of retained earnings, shown in Tables 2, 3, and 4, along with the 2014 balance sheet. In addition, he has compiled the 2014 ratio values and industry average ratio val- ues for 2015, which are applicable to both 2014 and 2015 and are summarized in Table 5. He is quite pleased to have achieved record earnings of $48,000 in 2015, but he is concerned about the firm's cash flows. Specifically, he is finding it more and more difficult to pay the firm's bills in a timely and more difficult to pay the firm's bills in a timely manner and generate cash flows to investors, both creditors and owners. To gain insight into these cash flow problems, Stanley is planning to deter- mine the firm's 2015 operating cash flow (OCF) and free cash flow (FCF). Stanley is further frustrated by the firm's inability to afford to hire a software developer to complete de- velopment of a cost estimation package that is be- lieved to have "blockbuster sales potential. Stanley began development of this package 2 years ago, but the firm's growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product. Stanley's reluctance to fill this position stems from his concern that the added $80,000 per year in salary and benefits for the position would certainly lower the firm's earnings per share (EPS) over the next couple of years. Although the project's success is in no way guaranteed, Stanley believes that if the money were spent to hire the software developer, the firm's sales and earnings would significantly rise once the 2- to 3-year development, production, and marketing process was completed. With all these concerns in mind, Stanley set out to review the various data to develop strategies that would help ensure a bright future for Track Soft- ware. Stanley believed that as part of this process, a thorough ratio analysis of the firm's 2015 results would provide important additional insights. Table 2 Track Software, Inc., Income Statement (S000) for the Year Ended December 31, 2015 Table 2 Track Software, Inc., Income Statement ($000) for the Year Ended December 31, 2015 Sales revenue $ 1,550 Less: Cost of goods sold $ 1.030 Gross profits $ 520 Less: Operating expenses Selling expense $ 150 General and administrative expenses 270 Depreciation expense 11 Total operating expense 431 Operating profits (EBIT) $ 89 Less: Interest expense Net profits before taxes 60 Less: Taxes (20%) 12 Net profits after taxes Table 3 Track Software, Inc., Balance Sheet ($000) Decem- ber 31 Assets 2015 2014 $12 $ 31 Cash Marketable securities Accounts receivable 152 104 Inventories 191 145 Total current assets $421 $362 $195 $180 Gross fixed assets Less: Accumulated depreciation 63 52 Net fixed assets $132 $128 Total assets $553 $490 Liabilities and stockholders' equity Accounts payable Notes payable $136 $126 200 190 27 25 $363 $341 Accruals Total current liabilities Long-term debt $ 38 S 40 Total liabilities $401 $381 Common stock (50,000 shares out- Liabilities and stockholders' equity Accounts payable $136 $126 Notes payable 200 190 Accruals 27 Total current liabilities 25 $363 $341 $ 38 $ 40 Long-term debt Total liabilities $401 $381 Common stock (50,000 shares out- $ 20 $ 20 standing at $0.40 par value) Paid-in capital in excess of par - 30 | 30 Retained earnings 10259 Total stockholders' equity $152 $109 Total liabilities and stockholders' eq- $553 $490 uity Table 4 Track Software, Inc., Statement of Re- tained Earnings ($000) for the Year Ended De- cember 31, 2015 $ 59 Retained earnings balance (January 1, 2015) Plus: Net profits after taxes (for 2015) - 48 1_5 Less: Cash dividends on common stock (paid during 2015) $102 Retained earnings balance (December 31, 2015) Table 5 Ratio Actual 2014 Industry aver- age 2015 1.82 Current ratio 1.06 Quick ratio 0.63 Inventory turnover 10.40 Average collection pe- 29.6 riod days 1.10 12.45 20.2 days Total asset turnover 2.66 3.92 Debt ratio 0.78 0.55 3.0 5.6 Times interest earned ratio Gross profit margin 3 2.1% 42.3% 5.5% 12.4% Operating profit mar- gin Net profit margin 3.0% 4.0% 8.0% 15.6% Return on total assets (ROA) 36.4% 34.7% Return on common equity (ROE) 5.2 7.1 Price/earnings (P/E) ratio 2.2 Market/book (M/B) ra- 2.1 tio