Warf Computers, Inc., was founded 15 years ago by Nick Warf, a computer programmer. The small initial investment to start the company was made by Nick and his friends. Over the years, this same group has supplied the limited additional investment needed by the company in the form of both equity and short- and long-term debt. Recently the company has developed a virtual keyboard (VK). The VK uses sophisticated artificial intelligence algorithms that allow the user to speak naturally and have the computer input the text, correct spelling and grammatical errors, and format the document according to preset user guidelines. The VK even suggests alternative phrasing and sentence structure, and it provides detailed stylistic diagnostics. Based on aproprietary, very advanced software/hardware hybrid technology, the system is a full generation beyond what is currently on the market. To introduce the VK, the company will require significant outside investment.

Nick has made the decision to seek this outside financing in the form of new equity investments and bank loans. Naturally, new investors and the banks will require a detailed financial analysis. Your employer, Angus Jones & Partners, LLC, has asked you to examine the financial statements provided by Nick. Here are the balance sheets for the two most recent years and the most recent income statement:

Balance Sheets for 2014 and 2015

Nick has also providedthe following information: During the year the company raised $228,000 in new long-term debt and retired $197,000 in long-term debt. The company also sold $15,000 in new stock and repurchased $66,000 in stock. The company purchased $1,482,000 in fixed assets and sold $429,000 in fixed assets.Angus has asked you to prepare the financial statement of cash flows and the accounting statement of cash flows. He has also asked you to answer the following questions:

1.Is the company able to distribute part of the cash flow to creditors?To this aim, calculate the cash flow to bondholders and stockholders.In addition to that, check whether the firm is experiencing a positive or negative change in cash (accounting cash flow).

2.Do you thinkthe accounting statement of cash flowsaccurately describes the cash flows ofthe company?

3.In light of your previous answers, comment on Nicks expansion plans.

4.For part (4), consider the Balance Sheet of Warf Computers in 2015. Let us suppose that sales are expected to increase by 10%.

What will be the External Financing Neededto support this increase in sales? Construct the Pro-Forma Income Statement and the Pro-Forma Balance Sheet.Comment your result.

To answer part (4), assume that costs vary directly with sales, but depreciationand interest expense arenot affected by any change in the sales level. It takes time for the initial investment to depreciate, so, to simplify the analysis, we are going to assume that depreciation isunaffected by changes in sales.Similarly, as we will see when studying bonds, the payment to bondholders is fixed in any period.Further, assume that all assets (i.e., current and fixed) vary directly with sales. Regarding the current liabilities, only accounts payable respond to a change in sales. Accruedexpenses are periodic expenses that have been incurred but will be paid at some future date and for which there is no actual documentation(i.e., no invoice available, for instance). Given the limited growth rate of sales, we will be assuming that accruedexpenses do not change.Finally, use the same assumptions used in class regarding long-term debt and equity. More in detail, assume that long-term liabilities do not change with a change in sales as they strongly depend upon managerial decisions that taketime to be approved and thus be effective. The change in equity will be driven by the change in accumulated retained earnings.

WARF COMPUTERS Balance Sheet ($ in thousands) 2015 2014 2015 2014 Current assets Current liabilities Cash and equivalents Accounts receivable Inventories Other $ 452 $ 391 668 663 78 Accounts payable Accrued expenses $ 519 247 485 716 641 92 401 $ 766 $ 886 $ 330 159 Total current liabilities Total current assets $1.901 $1.800 Long-term liabilities Deferred taxes Long-term debt Fixed assets 1.179 1.148 Property, plant, and $4,148 %3.179 equipment Less accumulated Total long-term liabilities $1,509 $1.307 depreciation 1,340 1,092 Stockholders' equity $ 21 $2 Preferred stock Common stock Capital surplus Accumulated retained Net property, plant, and $2,808 $2,087 709 $3.601 $%2.796 126 794 2.478 126 779 1.603 equipment 793 Intangible assets and others Total fixed assets earnings Less treasury stock 192 126 $3.227 $%2.403 Total equity Total liabilities and shareholders equity $5,502 $4,596 Total assets $5,502 $4,596