Introduction to Corporate Finance SECTION A Integrative Case Bright Works SOFTWARE Seven years ago, after 15 years in public accounting, Bob Booker, CPA, resigned his position as a Manager of Cost Systems for Davis, Cohen, and O'Brien Public Accountants and started Bright Works Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and O'Brien, Bob had spent nights and weekends developing a sophisticated cost-accounting software program that became Bright Works' initial product offering. As the firm grel, Bob planned to develop and expand the software product offerings - all of which would be related to streamlining the accounting processes of medium - to large-sized manufacturers. Although Bright Works experienced losses during its first 2 years of operation - 2004 and 2005 - its profit'has increased steadily from 2006 to the present (2010). The firm's profit history, including dividend payments and contributions to retained earnings, is summarized in Table 1. Bob started the firm with a $100,000 investment - his savings of $50,000 as equity and a $50,000 long-term loan form the bank. He had hoped to maintain his initial 100 percent ownership in the corporation, but after experiencing a $50,000 loss during the first year of operation (2004), he sold 60 percent of the stock to a group of investors to obtain needed funds. Since then, no other stock transactions have taken place. Although he owns only 40 percent of the firm, Bob actively manages all aspects 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 2009 and $5.28 per share in 2010 Bob has just prepared the firm's 2010 income statement, balance sheet, and statement of retained earnings, shown in Tables 2 (below), 3 and 4 (below), along with the 2009 balance sheet. In addition, he has compiled the 2009 ratio values and industry average ratio values for 2010, which are applicable to both 2009 and 2010, and are summarized in table 5. He is quite pleased to have achieved record earnings of $48,000 in 2010, 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 manner and generate cash flows to investors - both creditors and owners. To gain insight into these cash flow problems, Bob is planning to determine the firm's 2010 operating cash flow (OCF) and free cash flow (FCF). Bob is further frustrated by the firm's inability to afford to hire a software developer to complete development of a cost estimation package that is believed to have "blockbuster" sales potential. Bob 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. Bob'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 this project's success is in no way guaranteed, Bob 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. Bright Works Software, Inc Earnings Per Share (EPS) Since inception Table 1 Year 2004 2005 2006 2007 2008 2009 2010 Net Profits After Taxes ($50,000.00 ($20,000.00) $15,000.00 $35,000.00 $40,000.00 $43,000.00 $48,000.00 Common Dividends Paid $0.00 $0.00 $0.00 $0.00 $1,000.00 $3,000.00 $5 000.00 Contribution to retained earnings ($50,000.00) ($20,000.00) $15,000.00 $35,000.00 $39.000.00 $40,000.00 $43 000.00 Introduction to Corporate Finance SECTION A Integrative Case Bright Works SOFTWARE Seven years ago, after 15 years in public accounting, Bob Booker, CPA, resigned his position as a Manager of Cost Systems for Davis, Cohen, and O'Brien Public Accountants and started Bright Works Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and O'Brien, Bob had spent nights and weekends developing a sophisticated cost-accounting software program that became Bright Works' initial product offering. As the firm grel, Bob planned to develop and expand the software product offerings - all of which would be related to streamlining the accounting processes of medium - to large-sized manufacturers. Although Bright Works experienced losses during its first 2 years of operation - 2004 and 2005 - its profit'has increased steadily from 2006 to the present (2010). The firm's profit history, including dividend payments and contributions to retained earnings, is summarized in Table 1. Bob started the firm with a $100,000 investment - his savings of $50,000 as equity and a $50,000 long-term loan form the bank. He had hoped to maintain his initial 100 percent ownership in the corporation, but after experiencing a $50,000 loss during the first year of operation (2004), he sold 60 percent of the stock to a group of investors to obtain needed funds. Since then, no other stock transactions have taken place. Although he owns only 40 percent of the firm, Bob actively manages all aspects 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 2009 and $5.28 per share in 2010 Bob has just prepared the firm's 2010 income statement, balance sheet, and statement of retained earnings, shown in Tables 2 (below), 3 and 4 (below), along with the 2009 balance sheet. In addition, he has compiled the 2009 ratio values and industry average ratio values for 2010, which are applicable to both 2009 and 2010, and are summarized in table 5. He is quite pleased to have achieved record earnings of $48,000 in 2010, 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 manner and generate cash flows to investors - both creditors and owners. To gain insight into these cash flow problems, Bob is planning to determine the firm's 2010 operating cash flow (OCF) and free cash flow (FCF). Bob is further frustrated by the firm's inability to afford to hire a software developer to complete development of a cost estimation package that is believed to have "blockbuster" sales potential. Bob 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. Bob'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 this project's success is in no way guaranteed, Bob 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. Bright Works Software, Inc Earnings Per Share (EPS) Since inception Table 1 Year 2004 2005 2006 2007 2008 2009 2010 Net Profits After Taxes ($50,000.00 ($20,000.00) $15,000.00 $35,000.00 $40,000.00 $43,000.00 $48,000.00 Common Dividends Paid $0.00 $0.00 $0.00 $0.00 $1,000.00 $3,000.00 $5 000.00 Contribution to retained earnings ($50,000.00) ($20,000.00) $15,000.00 $35,000.00 $39.000.00 $40,000.00 $43 000.00