Computron Inc. is a public corporation specializing in software manufacturing. The company designs and develops software programs that allow users to create their own documents, apps, animations, and other media content. The company’s sales revenue and profit margins have decreased over the years because of the Covid-19 pandemic and complaints of some parents about the effect of video games on their kids’ social life and academic performance.
The company recently hired Jenny Cochran, a graduate of UC to assist the chairman of the board to turnaround the fortunes of the company. Cochran recommendations included doubling the plant capacity, opening new sales offices outside the home territory, and launching an expensive advertising campaign to boost cash flows and stock price. Cochran believes that undertaking of such capital budgeting projects would increase sales, net income, and free cash flows to boost the stock price.
The corporate tax rate is 40%.
The following financial statement and reports were made available by the finance department for analysis:
Computron’s Income Statement
2019 2020
Net sales 2,059,200 3,500,640
Cost of Goods Sold 1,718,400 2,988,000
Other Expenses 204,000 432,000
Depreciation and amortization 11,340 70,176
Total Operating Costs 1,933,740 3,490,176
Earnings before interest and taxes (EBIT) 125,460 10,464
Less interest 37,500 105,600
Pre-tax earnings 87,960 (95,136)
Taxes (40%) 35,184 (38,054)
Net Income 52,776 (57,082)
Computron’s Balance Sheet
Assets
Cash and equivalents 5,400 4,369
Short-term investments 29,160 12,000
Accounts receivable 210,720 379,296
Inventories 429,120 772,416
Total current assets 674,400 1,168,081
Gross fixed assets 294,600 721,770
Less: Accumulated depreciation 87,720 157,896
Net plant and equipment 206,880 563,874
Total assets 881,280 1,731,955
Liabilities and equity
Accounts payable 87,360 194,400
Notes payable 120,000 432,000
Accruals 81,600 170,976
Total current liabilities 288,960 797,376
Long-term bonds 194,059 600,000
Common Stock 276,000 276,000
Retained Earnings 122,261 58,579
Total Equity 398,261 334,579
Total Liabilities and Equity 881,280 1,731,955
a. Explain to the chairman of the board three properties of future cashflows that would likely help increase Computron’s value.
b. What is Computron’s net operating profit after taxes (NOPAT) for 2020?
c. Calculate Computron’s free cash flow for 2020 if net investment in total operating capital is $671,419.
d. Explain to the chairman of the board five uses of free cash flow to help maximize the value of the firm.
e. Explain Economic Value Added (EVA) and compute Computron’s EVA for 2020 if total net operating capital is $1,354,579? The company’s weighted average cost of capital (WACC) is 10.0%.
f. Calculate the following profitability ratios for Computron in 2020:
g.
i. Operating profit margin
ii. Return on assets (ROA)
iii. Return on equity (ROE)
iv. Basic Earning Power (BEP)
h. Calculate the following asset management ratios for Computron in 2020:
i. total assets turnover
ii. Days sales outstanding (DSO)
i. Calculate the following liquidity and debt management ratios for Computron in 2020:
iii. Current ratio
iv. Quick ratio
v. Debt-to-assets ratio
vi. Times-interest earned ratio
j. Given the following industry ratios for 2020, how do you evaluate the financial performance of Computron (poor or better) and explain:
a. Operating profit margin 7.20%
b. Basic Earning Power 15.60%
c. ROE 15.40%
d. Return on Assets 10.80%
e. Total Assets turnover 1.5
f. Days sales outstanding 28.00
g. Current ratio 2.50
h. Quick ratio 1.90
i. Debt-to-assets ratio 15%
j. Times-interest-earned 13.00
i. Computron has a negative free cash flow in 2020. The financial manager explains to the board that there is nothing wrong with value-adding growth, even if it causes negative free cash flows in the short-term. Using return on invested capital (ROIC) performance evaluation approach, determine whether Cochran’s recommendation is adding value. Total operating capital of the company is $1,354,579 and WACC is 10%.
Sample Answer
Sample Answer
Turning Around Computron Inc.: A Financial Analysis and Strategic Recommendations
Computron Inc., a public corporation specializing in software manufacturing, has faced challenges in recent years due to the impact of the Covid-19 pandemic and concerns about the effects of video games on children’s social and academic lives. In an effort to reverse this downward trend, Jenny Cochran, a recent graduate hired by the company, has proposed several strategic initiatives to increase sales, net income, and stock price. This essay will provide a comprehensive analysis of Computron’s financial statements and offer strategic recommendations based on the data provided.
Properties of Future Cashflows
1. Predictability: Future cash flows that are stable and predictable can increase Computron’s value by reducing uncertainty for investors and stakeholders.
2. Growth Potential: Cash flows that show potential for growth through new product development or market expansion can drive increased value for the company.
3. Consistency: Consistent cash flows demonstrate the company’s ability to generate profits over time, enhancing its value in the eyes of investors and creditors.
Net Operating Profit After Taxes (NOPAT) for 2020
To calculate NOPAT for 2020, we subtract taxes from earnings before interest and taxes (EBIT):
[NOPAT = EBIT \times (1 – Tax Rate)]
[NOPAT = 10,464 \times (1 – 0.40)]
[NOPAT = $6,278.40]
Free Cash Flow Calculation for 2020
Free cash flow can be calculated as:
[Free Cash Flow = NOPAT – Net Investment in Total Operating Capital]
Given that net investment in total operating capital is $671,419:
[Free Cash Flow = $6,278.40 – $671,419]
[Free Cash Flow = -$665,140.60]
Uses of Free Cash Flow to Maximize Firm Value
1. Investing in Research and Development: Enhancing product offerings to stay competitive in the market.
2. Debt Repayment: Lowering debt levels to improve financial health and reduce interest expenses.
3. Dividend Payments: Rewarding shareholders and attracting new investors.
4. Acquisitions: Strategic acquisitions to expand market presence or diversify product lines.
5. Stock Buybacks: Repurchasing shares to signal confidence and potentially increase stock price.
Economic Value Added (EVA) and Calculation for 2020
Economic Value Added (EVA) measures a company’s true economic profit after considering the cost of capital. The formula for EVA is:
[EVA = NOPAT – (Total Net Operating Capital \times WACC)]
Given Total Net Operating Capital of $1,354,579 and WACC of 10%:
[EVA = $6,278.40 – ($1,354,579 \times 0.10)]
[EVA = $6,278.40 – $135,457.90]
[EVA = -$129,179.50]
Profitability Ratios for Computron in 2020
i. Operating Profit Margin = ( \frac{EBIT}{Net Sales} \times 100 )
ii. Return on Assets (ROA) = ( \frac{Net Income}{Total Assets} \times 100 )
iii. Return on Equity (ROE) = ( \frac{Net Income}{Total Equity} \times 100 )
iv. Basic Earning Power (BEP) = ( \frac{EBIT}{Total Assets} )
Asset Management Ratios for Computron in 2020
i. Total Assets Turnover = ( \frac{Net Sales}{Total Assets} )
ii. Days Sales Outstanding (DSO) = ( \frac{Accounts Receivable}{Average Daily Sales} )
Liquidity and Debt Management Ratios for Computron in 2020
iii. Current Ratio = ( \frac{Current Assets}{Current Liabilities} )
iv. Quick Ratio = ( \frac{Current Assets – Inventories}{Current Liabilities} )
v. Debt-to-Assets Ratio = ( \frac{Total Debt}{Total Assets} )
vi. Times-Interest Earned Ratio = ( \frac{EBIT}{Interest Expense} )
Evaluation of Financial Performance
Comparing Computron’s ratios with industry benchmarks can provide insights into its financial performance. If Computron’s ratios are below industry averages, it may indicate poor performance that requires strategic adjustments.
Return on Invested Capital (ROIC) Analysis
ROIC compares a company’s net operating profit after taxes with its total net operating capital to assess value creation. The formula for ROIC is:
[ROIC = \frac{NOPAT}{Total Net Operating Capital}]
Given that Total Operating Capital is $1,354,579 and WACC is 10%:
[ROIC = \frac{$6,278.40}{$1,354,579} = 0.46%]
Based on the ROIC calculation, Cochran’s recommendation may not be adding significant value to Computron in the short term due to the negative free cash flow observed in 2020.
In conclusion, a thorough analysis of Computron’s financial statements reveals areas for improvement and strategic focus to enhance the company’s value and financial performance. By prioritizing cash flow optimization, profitability enhancement, and efficient capital allocation, Computron can navigate challenges and position itself for sustainable growth in the competitive software manufacturing industry.
