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Chapter 2 Mini Case

Situation
Donna Jamison, a recent graduate of the University of Tennessee with four years of banking experience, was
recently brought in as assistant to the chairman of the board of Computron Industries, a manufacturer of
electronic calculators. The company doubled its plant capacity, opened new sales offices outside its home
territory, and launched an expensive advertising campaign.
Computron's results were not satisfactory, to put it mildly. Its board of directors, which consisted of its
president and vice-president plus its major stockholders (who were all local business people), was most upset
when directors learned how the expansion was going. Suppliers were being paid late and were unhappy, and
the bank was complaining about the deteriorating situation and threatening to cut off credit. As a result, Al
Watkins, Computrons president, was informed that changes would have to be made, and quickly, or he
would be fired. Also, at the board's insistence Donna Jamison was brought in and given the job of assistant
to Fred Campo, a retired banker who was Computron's chairman and largest stockholder. Campo agreed to
give up a few of his golfing days and to help nurse the company back to health, with Jamison's help.
Jamison began by gathering financial statements and other data.
Assume that you are Jamison's assistant, and you must help her answer the following questions for Campo.

A
B
C
25 Computron's Income Statement

26
27

2009

2010

29 Net sales

$3,432,000

$5,834,400

30 Cost of Goods Sold

$2,864,000

$4,980,000

$340,000

$720,000

28 INCOME STATEMENT

31 Other Expenses
32 Depreciation

$18,900

$116,960

$3,222,900

$5,816,960

34 Earnings before interest and taxes (EBIT)

35 Less interest

$209,100
$62,500

$17,440
$176,000

36 Earnings before taxes (EBT)

37 Taxes (40%)

$146,600
$58,640

-$158,560
-$63,424

$87,960

-$95,136

$22,000
40%

$11,000
40%

33 Total Operating Costs

38 Net Income
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Dividends
Tax rate

a. (1.) What effect did the expansion have on sales and net income? Answer: See Chapter 2 Slides
Computron's Balance Sheets
2009

2010

Assets
Cash and equivalents
Short-term investments
Accounts receivable
Inventories
Total current assets
Gross fixed assets
Less: Accumulated depreciation
Net plant and equipment
Total assets

$9,000
$48,600
$351,200
$715,200
$1,124,000
$491,000
$146,200
$344,800
$1,468,800

$7,282
$20,000
$632,160
$1,287,360
$1,946,802
$1,202,950
$263,160
$939,790
$2,886,592

Liabilities and equity

Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Common Stock
Retained Earnings
Total Equity
Total Liabilites and Equity

$145,600
$200,000
$136,000
$481,600
$323,432
$460,000
$203,768
$663,768
$1,468,800

$324,000
$720,000
$284,960
$1,328,960
$1,000,000
$460,000
$97,632
$557,632
$2,886,592

a. (2.) What effect did the expansion have on the asset side of the balance sheet? Answer: See Chapter 2 Slides
Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is
shown below for Computron.
Computron's Statement of Cash Flows
2010
Operating Activities
Net Income before preferred dividends
Noncash adjustments
Depreciation and amortization
Due to changes in working capital
Change in accounts receivable
Change in inventories
Change in accounts payable
Change in accruals
Net cash provided by operating activities

($280,960)
($572,160)
$178,400
$148,960
($503,936)

Investing activities
Cash used to acquire fixed assets
Change in short-term investments

($711,950)
$28,600

($95,136)
$116,960

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128

A
B
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Net cash provided by investing activities

Financing Activities
Change in notes payable
Change in long-term debt
Payment of cash dividends
Net cash provided by financing activities

G
($683,350)

$520,000
$676,568
($11,000)
$1,185,568

Net change in cash and equivilents

Cash and securities at beginning of the year

($1,718)
$9,000

Cash and securities at end of the year

$7,282

b. What do you conclude from the statement of cash flows? Answer: See Chapter 2 Slides
c. What is free cash flow? Why is it important? What are the five uses of FCF? Answer: See Chapter 2 Slides
d. What is Computrons net operating profit after taxes (NOPAT)? What are operating current assets? What are
operating current liabilities? How much net operating working capital and total net operating capital does Computron
Net Operating Profit After Taxes
NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets.
NOPAT10 =
=
=

EBIT
$17,440
$10,464

x
x

(1-T)
60%

NOPAT09 =
=
=

EBIT
$209,100
$125,460

x
x

(1-T)
60%

Net Operating Working Capital

Those current assets used in operations are called operating current assets, and the current liabilities that result from
operations are called operating current liabilities. Net operating working capital is equal to operating current assets minus
operating current liabilities.

NOWC10 =
129
130
131
132

=
=

NOWC09 =
133
134
135
136
137
138
139
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144
145
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148
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=
=

Operating
current
assets
$1,926,802
$1,317,842
Operating
current
assets
$1,075,400
$793,800

Operating
current
liabilities
$608,960

Operating
current
liabilities
$281,600

Total Net Operating Capital

The Total OperatingCapital is Net Operating Working Capital plus any fixed assets.
TOC10 =
=
=

NOWC
$1,317,842
$2,257,632

+
+

Fixed assets
$939,790

TOC09 =
=
=

NOWC
$793,800
$1,138,600

+
+

Fixed assets
$344,800

e. What is Computrons free cash flow (FCF)? What are Computrons net uses of its FCF?
Free Cash Flow
Computron's Free Cash Flow caluclation is the cash flow actually availabe for distribution to investors after the company
has made all necessary investments in fixed assets and working capital to sustain ongoing operations.
FCF10 =
=

NOPAT
$10,464.0

Net Investment in Operating Capital

$1,119,032

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A
=

B
-$1,108,568

Uses of FCF:
After-tax interest payment =
Reduction (increase) in debt =
Payment of dividends =
Repurchase (Issue) stock =
Purchase (Sale) of short-term investments =
Total uses of FCF =

2010
$105,600
-$1,196,568
$11,000
$0
-$28,600
-$1,108,568

f. Calculate Computrons return on invested capital. Computron has a 10% cost of capital (WACC). Do you think
Computrons growth added value?
2009
2010
Cost of Capital (WACC)
10%
10%

Return on Invested Capital

The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.
ROIC10 =
=
=

NOPAT
$10,464.0
0.5%

Operating Capital
$2,257,632

ROIC09 =
=
=

NOPAT
$125,460.0
11.0%

Operating Capital
$1,138,600

g. What is Computron's EVA? The after-tax cost of capital was 10 percent in both years.

Economic Value Added

Economic Value Added represents Computron's residual income that remains after the cost of all capital, including equity
capital, has been deducted.
EVA10 =
=
=
=

NOPAT
$10,464
$10,464
-$215,299

Operating Capital
x WACC
$2,257,632
x
10%
$225,763.2

EVA09 =
=
=
=

NOPAT
$125,460
$125,460
$11,600

Operating Capital
x WACC
$1,138,600
x
10%
$113,860.0

h. What happened to Computron's market value added (MVA)?

Year-end common stock price
Year-end shares outstanding (in millions)
Earnings per share (EPS)
Dividends per share (DPS)

$8.50
100,000
($0.95)
$0.11

$6.00
100,000
$0.88
$0.22

Market Value Added

Assume that the market value of debt is equal to the book value of debt. In this case, Market Value Added (MVA) is the
difference between the market value of Computron's stock and the amount of equity capital supplied by shareholders.
MVA10 =
=
=
=

Stock price
$6.00

MVA09 =
=
=
=

Stock price
$8.50

x
x
$600,000

# of shares
100,000

Total common equity

$557,632
$557,632

x
x
$850,000

# of shares
100,000

Total common equity

$663,768
$663,768

$42,368

$186,232