Finance Computron Having a Negative Free Cash Flow Questions
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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
- Explain to the chairman of the board three properties of future cashflows that would likely help increase Computron’s value.
- What is Computron’s net operating profit after taxes (NOPAT) for 2020?
- Calculate Computron’s free cash flow for 2020 if net investment in total operating capital is $671,419.
- Explain to the chairman of the board five uses of free cash flow to help maximize the value of the firm.
- 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%.
- Calculate the following profitability ratios for Computron in 2020:
-
- Operating profit margin
- Return on assets (ROA)
- Return on equity (ROE)
- Basic Earning Power (BEP)
- Calculate the following asset management ratios for Computron in 2020:
- total assets turnover
- Days sales outstanding (DSO)
- Calculate the following liquidity and debt management ratios for Computron in 2020:
- Current ratio
- Quick ratio
- Debt-to-assets ratio
- Times-interest earned ratio
- 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
- 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%
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