[Please explain the process towards the answer.]

Rockford Medical Supplies stock price had been lagging its industry averages, so its board of directors brought in a new CEO, Jaiden Lee. Lee had brought in Ashley Novak, a finance MBA who had been working for a consulting company, to replace the old CFO, and Lee asked Ashley to develop the financial planning section of the strategic plan. In her previous job, Novaks primary task had been to help clients develop financial forecasts, and that was one reason Lee hired her.

Novak began as she always did, by comparing Rockfords financial ratios to the industry averages. If any ratio was substandard, she discussed it with the responsible manager to see what could be done to improve the situation. The following data shows Rockfords latest financial statements plus some ratios and other data that Novak plans to use in her analysis.

Rockford Medical Supplies (Millions of Dollars Except Per Share Data)
Balance Sheet, 12/31/2013		Income Statement, Year Ending 2013
Cash	$20	Sales	$2,000
Accts. rec.	280	Op. costs	1,800
Inventories	400	Depreciation	50
Total CA	$700	EBIT	$150
Net fixed assets	500	Interest	40
Total assets	$1,200	Pretax earnings	$110
		Taxes (40%)	44
Accts. pay. & accruals	$80	Net income	$66
Line of credit	$0
Total CL	$80	Dividends	$20.00
Long-term debt	500	Add. to RE	$46.00
Total liabilities	$580	Common shares	10
Common stock	420	EPS	$6.60
Retained earnings	200	DPS	$2.00
Total common equity	$620	Ending stock price	$52.80
Total liabilities & equity	$1,200

Selected Additional Data for 2013
	Rockford	Industry
Op. costs/Sales	90.00%	88.00%
Depr./FA	10.00%	12.00%
Cash/Sales	1.00%	1.00%
Receivables/Sales	14.00%	11.00%
Inventories/Sales	20.00%	15.00%
Fixed assets/Sales	25.00%	22.00%
Acc. pay. & accr. / Sales	4.00%	4.00%
Tax rate	40.00%	40.00%
ROIC	8.00%	12.50%
NOPAT/Sales	4.50%	5.60%
Total op. capital/Sales	56.00%	45.00%
Total liability/Total assets	48.30%	36.70%
Times interest earned	3.8	8.9
Return on assets (ROA)	5.50%	10.20%
Profit margin (M)	3.30%	4.99%
Sales/Assets	1.67	2.04
Assets/Equity	1.94	1.56
Return on equity (ROE)	10.60%	16.10%
P/E ratio	8	16

Note: Rockford was operating at full capacity in 2013. Also, you may observe small differences in items like the ROE when calculated in different ways. Any such differences are due to rounding, and they can be ignored.

QUESTIONS:

a) Using Rockfords data and its industry averages, how well run would you say Rockford appears to be in comparison with other firms in its industry? What are its primary strengths and weaknesses? Be specific in your answer, and point to various ratios that support your position. Also, use the Du Pont equation as one part of your analysis.

b) Use the AFN equation to estimate Rockfords required new external capital for 2014 if the sale growth rate is 10%. Assume that the firms 2013 ratios will remain the same in 2014. (Hint: Rockford was operating at full capacity in 2013.)

c) Define the term capital intensity. Explain how a decline in capital intensity would affect the AFN, other things held constant. Would economies of scale with rapid growth affect capital intensity, other things held constant? Also, explain how changes in each of the following would affect AFN, holding other things constant: the growth rate, the amount of accounts payable, the profit margin, and the payout ratio.

d) Define the term self-supporting growth rate. What is Rockfords self-supporting growth rate? Would the self-supporting growth rate be affected by a change in the capital intensity ratio or the other factors mentioned in the previous question? Other things held constant, would the calculated capital intensity ratio change over time if the company were growing and were also subject to economies of scale and/or lumpy assets?

e) Use the following assumptions to answer the questions below:

- Operating ratios remain unchanged.

- Sales will grow by 10%, 8%, 5%, and 5% for the next four years.

- The target weighted average cost of capital (WACC) is 9%. This is the No Change scenario because operations remain unchanged.

e.1) For each of the next four years, forecast the following items: sales, cash, accounts receivable, inventories, net fixed assets, accounts payable & accruals, operating costs (excluding depreciation), depreciation, and earnings before interest and taxes (EBIT).

e.2) Using the previously forecasted items, calculate for each of the next four years the net operating profit after taxes (NOPAT), net operating working capital, total operating capital, free cash flow, (FCF), annual growth rate in FCF, and return on invested capital. What does the forecasted free cash flow in the first year imply about the need for external financing? Compare the forecasted ROIC compare with the WACC. What does this imply about how well the company is performing? Hint, use EVA to discuss the performance.

EVA = (ROIC WACC) (Invested Capital)

e.3) Assume that FCF will continue to grow at the growth rate for the last year in the forecast horizon (Hint: 5%). What is the horizon value at 2017? What is the present value of the horizon value? What is the present value of the forecasted FCF? What is the current value of operations? Using information from the 2013 financial statements, what is the current estimated intrinsic stock price?

	Actual 2013	Forecast
		2014	2015	2016	2017
Sales growth rate:		10%	8%	5%	5%
Op. costs/Sales:	90%	90%	90%	90%	90%
Depr./FA	10%	10%	10%	10%	10%
Cash/Sales:	1%	1%	1%	1%	1%
Acct. rec. /Sales	14%	14%	14%	14%	14%
Inv./Sales:	20%	20%	20%	20%	20%
FA/Sales:	25%	25%	25%	25%	25%
AP & accr. / Sales:	4%	4%	4%	4%	4%
Tax rate:	40%	40%	40%	40%	40%
Rate on all debt		8%	8%	8%	8%
Div. growth rate:	5%	10%	10%	10%	10%
Target WACC		9%