Principles of Managerial Finance 14th Ed. Lawrence Gitman, Chad Zutter

Integrative Case 2 Track Management (pg. 221-224. See these pages for tables relating to question)

Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his position as manager of cost systems for Davis, Cohen, and OBrien Public Accountants and started Track Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and OBrien, Stanley had spent nights and weekends developing a sophisticated cost-accounting software program that became Tracks initial product offering. As the firm grew, Stanley 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 Track experienced losses during its first 2 years of operation2009 and 2010its profit has increased steadily from 2011 to the present (2015). The firms profit history, including dividend payments 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 corporation, but after experiencing a $50,000 loss during the first year of operation (2009), 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, Stanley actively manages all aspects of its activities; the other stockholders are not active in management of the firm. The firms stock was valued at $4.50 per share in 2014 and at $5.28 per share in 2015.

Stanley has just prepared the firms 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 values 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 firms cash flows. Specifically, he is finding it more and more difficult to pay the firms 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 determine the firms 2015 operating cash flow (OCF) and free cash flow (FCF). Stanley is further frustrated by the firms inability to afford to hire a software developer to complete development of a cost estimation package that is believed to have blockbuster sales potential. Stanley began development of this package 2 years ago, but the firms growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product. Stanleys 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 firms earnings per share (EPS) over the next couple of years. Although the projects success is in no way guaranteed, Stanley believes that if the money were spent to hire the software developer, the firms 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 Software. Stanley believed that as part of this process, a thorough ratio analysis of the firms 2015 results would provide important additional insights.

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.

e. What recommendation would you make to Stanley regarding hiring a new software developer? Relate your recommendation here to your responses in part a.