Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his position as manager of cost systems for Davis, Cohen, and O'Brien Public Accountants and started Track Software 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 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 operation?2013 and 2014?its profit has increased steadily from 2015 to the year just ended (2019). The firm's profit history, including dividend payments and contributions to retainedearnings, is summarized inTable1.

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% ownership in the corporation, but after experiencing a $50,000 loss during the first year of operation (2013), he sold 60% 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% of the firm, Stanley actively manages all aspects of its activities; the other stockholders are not active in its management. The firm's stock was valued at $4.50persharein 2018 and at $5.28persharein 2019.

Stanley has just prepared the firm's 2019 income statement, balance sheet, and statement of retainedearnings, shown inTables2,3, and4, respectively, along with the 2018 balance sheet. In addition, he has compiled the 2018 ratio values and industry average ratio values for 2019, which are applicable to both 2018 and 2019 and are summarized inTable5. He is quite pleased to have achieved recordearnings of $48,000 in 2019, 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, Stanley is planning to determine the firm's 2019 operating cash flow (OCF) and free cash flow (FCF).

Stanley is further frustrated that the firm cannot afford to hire a software developerto complete development of a cost estimation package that he believes has "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 development. Stanley's reluctance to fill this position stems from his concern that the added $80,000peryear in salary and benefits for the position would certainly lower the firm'searningspershare(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 andearnings 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 firm's 2019 results would provide important additional insights.

To Do

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.
3. Calculate the firm'searningspershare(EPS) for each year, recognizing that the number ofshares of common stock outstanding has remained unchanged since the firm's inception. Comment on the EPSperformance in view of your response in parta.
4. Use the financial data presented to determine Track's operating cash flow (OCF) and free cash flow (FCF) in 2019. Evaluate your findings in light of Track's current cash flow difficulties.
5. Analyze the firm's financial condition in 2019 as it relates to (1) liquidity, (2) activity, (3) debt, (4) profitability, and (5) market, using the financial statements provided inTables2and3and the ratio data included inTable5. Be sure to evaluate the firm on both a cross-sectional and a time-series basis.
6. What recommendation would you make to Stanley regarding hiring a new software developer? Relate your recommendation here to your responses in parta.
7. Track Software paid $5,000 in dividends in 2019. Suppose that an investor approached Stanley about buying 100% of his firm. If this investor believed that by owning the company he could extract $5,000peryear in cash from the company inperpetuity, what do you think the investor would be willing to pay for the firm if the required return on this investment is 10%?
8. Suppose you believed that the FCF generated by Track Software in 2019 could continue forever. You are willing to buy the company in order to receive thisperpetual stream of free cash flow. What are you willing to pay if you require a 10% return on your investment?

5: Time Value DfMoney Although Track experienced losses during its first 2 years ofopewatiun72013 and 2014iits prot has incleased steadily flum 2015 to the year just ended [2019). The nn's plot history, including dividend payments and oonoibutions to retained eamings, is summarized in Table 1 E. Table 1 Track Software Inc.. Prolit. Dividends. and Retained Earnings. 20132019 Year Net prolits after taxes Dividends paid Contribution to reined earnings 2013 e$50,000 $ 0 e$50,000 0 : 4850.000 2014 720.000 0 720.000 * 0 : 720.000 2015 15,000 0 15,00070 = 15,000 2016 35.000 0 35,000 i 0 : 35,000 2017 40.000 1,000 40,000 n 1,000 : 39,000 2018 43,000 3,000 43,000 3,000 : 40,000 2019 48.000 5,000 48,000 n 5,000 : 43,000 Stanley started the firm wii a $100,000 investment: his savings of $50,000 as equity and a $50,000 longetemi loan from the bank. He had hoped to maintain his initial 100% ownership in the corporation, but after experiencing a $50,000 loss during the fist year of operation (2013), he sold 60% 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% of the rm, Stanley actively manages all aspects of its activities; the other stuckholdems are not active in its management. The lm's stock was valued at $4.50 peI share in 2018 and at $5.28 per share in 2019. P Pearson eText X +- CD etext-ise.pearson.com/courses/6190210/products/3CJ32C7 ATNQ/pages/abdaa95bc39444f7b7349fd07b549fbafdd3fff05?locale=&key=53472857910264913892020 5: Time Value of Money Q N A : Table 2 Track Software Inc., Income Statement ($000) for the Year Ended December 31, 2019 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 29 Net profits before taxes S 60 Less: Taxes (20%) 12 Net profits after taxes $ 48 Table 3 Track Software Inc., Balance Sheet ($000) December 31 Assets 2019 2018 Cash $ 12 $ 31X P Pearson eText +- CD etext-ise.pearson.com/courses/6190210/products/3CJ32C7 ATNQ/pages/abdaa95bc39444f7b7349fd07b549fbafdd3fff05?locale=&key=53472857910264913892020 E 5: Time Value of Money Q n A : Table 3 Track Software Inc., Balance Sheet ($000) December 31 Assets 2019 2018 Cash $ 12 $ 31 Marketable securities 66 82 Accounts receivable 152 104 Inventories 191 145 Total current asse $421 $362 Gross fixed assets $195 $180 cumulated depreciation 63 52 Net fixed assets $132 $128 Total assets $553 $490 Liabilities and stockholders' equity Accounts payable $136 $126 Notes payable 200 190 Accruals 27 25 Total current liabilities $363 $341 Long-term debt 38 40 Total liabilities $401 $38 Common stock (50,000 shares outstanding at $0.40 par value) $ 20 $ 20 Paid-in capital in excess of par 30 30 Retained earnings 102 59 Total stockholders' equity $152 $109 Total liabilities and stockholders' equity $553 $490P Pearson eText X +- CD etext-ise.pearson.com/courses/6190210/products/3CJ32C7 ATNQ/pages/abdaa95bc39444f7b7349fd07b549fbafdd3fff05?locale=&key=53472857910264913892020 5: Time Value of Money Q N A : Table 5 Ratio Actual 2018 Industry average 2019 Current ratio 1.06 1.82 Quick ratio 0.63 1.10 Inventory turnover 10.40 12.45 Average collection period 29.6 days 20.2 days Total asset turnover 2.66 3.92 Debt ratio 0.78 0.55 Times interest earned ratio 3.0 5.6 Gross profit margin 32.1% 42.3% Operating profit margin 5.5% 12.4% Net profit margin 3.0% 4.0% Return on total assets (ROA) 8.0% 15.6% Return on common equity (ROE) 36.4% 34.7% Price/earnings (P/E) ratio 5.2 7.1 Market/book (M/B) ratio 2.1 2.2 Stanley is further frustrated that the firm cannot afford to hire a software developer to complete development of a cost estimation package that he believes has "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 development.5: Time Value DfMoney Common stock (50.000 shares outs1anding a1$0.40 par value) Paideirl capital in excess of par Retained earnings Total stockholders' equity es and stockholders' equity $ 20 $ 20 30 30 102 59 $152 $109 $553 $490 Table 4 Track Software Inc., Statement of Retained Earnings ($000) for the Year Ended December 31. 2019 Retained earnings balance (January 1. 2019) Plus: Net profits after Iaxes (for 2019) Less: Cash dividends on common stock (paid during 2019) Retained earnings balance (December 31. 2019) $59 48 $102 Table 5 Ratio Actual 2018 Industry average 2019 Current ratio 1.06 1.82 Quick ratio 0.63 1.10 Inventory turnover 10.40 12.45 Average collection period 29.6 days 20.2 days Tulal asset turnover 2.66 3.92 Debt ratio 0.78 0.55