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Track Software Inc

Integrative Case Assignment 1


Rey-Anne Paynter 808000390

2/19/2013

MENG 6502:Financial Management Lecturer: Nagamuttu S. Arumugadasan

a. (1) Stanleys focus is on maximizing profits. This is the correct goal because the goal of any firm, and therefore its financial manager, should be to maximize its value and by extension the wealth of the shareholders. (2) There is potential for an agency problem if Stanley decides to go ahead and invest in the software developer. This investment will cause a temporary decrease in the earnings per share (EPS) of the firm which will mean fewer earnings at the present time for the stakeholders. This may be a problem if the goal of the shareholders is to gain money sooner than later. However, it the goal of the shareholders is simply to maximize wealth, there may not be an agency problem since the goal of the financial manager, Stanley, is the same as the shareholders. b. Since there is no preferred stock; Earnings available for common stockholders Net profit after taxes. No of shares of common stock outstanding = 50 000

Year
2006 2007 2008 2009 2010 2011 2012

Earnings per share (EPS)

EPS show a steady increase over the past five years indicating that Stanley is achieving his goal of maximizing profits. c. Operating Cash Flow(OCF) for 2012 OCF = {Earnings Before Interest and Taxes (1 Tax rate)} + Depreciation OCF = {EBIT (1 T)} + Depreciation = {$89 000 (1 0.20)} + $11 000 = $82 200 Free Cash Flow (FCF) for 2012 FCF = OCF1 Net Fixed Assets Investments Net Current Assets Investment FCF = OCF NFAI NCAI NFAI = Change in net fixed assets + Depreciation = ($132 000 $128 000) + $11 000 = $15 000 NCAI = Chance in current assets Change in (Accounts Payable + Accruals) = ($421 000 $62 000) {($136 000 + $27 000) ($126 000 + $25 000)} =$47 000 FCF = $82 200 $15 000 $47 000 = $20 200 Both the operating cash flow and the free cash flow are positive indicating that Stanley was able to generate adequate cash flow to cover both operating expenses and investments in assets. There was also $20 200 left over to pay to investors. d. (1) Liquidity 2012 Ratio Current Ratio Improving Quick Ratio Steady Poor Poor Time Series Evaluation Cross Sectional Evaluation

Although the liquidity of the firm has improved slightly (current ratio) or remained steady (quick ratio), the firms performance is considerably below average.

(2) Activity 2012 Ratio Inventory Turnover Deteriorating Average Period Collection Deteriorating Improving Poor Poor Very Poor Time Series Evaluation Cross Sectional Evaluation

Total Asset Turnover

The total asset turnover of the firm has improved but the inventory turnover and average collection period has deteriorated. The activity of the firm is also considerably below the industry average. (3) Debt 2012 Ratio Debt Ratio Decreasing Times Interest Earned Ratio Fairly Steady Poor Poor Time Series Evaluation Cross Sectional Evaluation

The debt ratio decreased in the times interest earned ratio improved. This indicates that the firm used more of its own money to generate profit in 2012 (rather than that of its creditors) and its ability to make contractual interest payments has improved. However, the firm fails to measure up to the industrial average yet again. (4) Profitability 2012 Ratio Gross Profit Margin Improving Operating Profit Margin Improving Net Profit Margin Improving Poor Very Poor Poor Time Series Evaluation Cross Sectional Evaluation

Return on Total Assets (ROA) Return on Common Equity (ROE)

Improving Slightly/ Stable Deteriorating

Poor Fair

The gross, operating and net profit margin and the return on total assets (ROA) have improved slightly showing that the profitability of the firm is fairly stable, demonstrating little improvement. Even so, these ratios are all still subpar. The return of common equity (ROE) has deteriorated, falling to below the industrial average. (5) Market 2012 Ratio Price/Earning (P/E) Ratio Market/Book (M/B) Ratio Time Series Evaluation Improving Deteriorating Cross Sectional Evaluation Poor Fair

The firms P/E ratio improved but remained bellowed the industry average, showing that the investors are gaining confidence in the firms future performance. The M/B ratio fell below from above the industrial average in 2011 to below in 2012 but still remains fair.

e. Stanley should try to find the money to hire the software developer since the ratios show that the firm should be performing better for a firm in this particular industry. In addition, the blockbuster sales potential implies a potential for increased profitability which falls in line with Stanleys focus.

f. The present value of a perpetuity creating a cash flow of $5 000 per year with a 10% interest rate = =

= $50 000

The investor would be willing to pay $50 000 for the firm.

g. The present value of a firm generating a perpetual stream of free cash flow of $20 200 per year with an interest rate of 10 % =

= $202 000

I would be willing to pay $202 000 for the firm.