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Net Income 369$ 264$
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A B C D E F G H I
Total assets 4,080$ 4,900$
11/20/2018
Situation
Computron’s Balance Sheets (Millions of Dollars)
2018 2019
Assets
Cash and equivalents 60$ 50$
Liabilities and equity
Accounts payable 300$ 400$
Notes payable 50 250
Accruals 200 240
Total current liabilities 550$ 890$
Long-term bonds 800 1,100
Total liabilities 1,350$ 1,990$
Common stock 1,000 1,000
Retained earnings 1,730 1,910
Total equity 2,730$ 2,910$
Total liabilities and equity 4,080$ 4,900$
Computron’s Income Statement (Millions of Dollars)
2018 2019
Net sales 5,500$ 6,000$
Cost of goods sold (Excluding depr. & amort.) 4,300 4,800
Other Data 2018 2019
Stock price $50.00 $30.00
Shares outstanding (millions) 100 100
Common dividends (millions) $90 $84
Tax rate 25% 25%
Weighted average cost of capital (WACC) 10.00% 10.00%
Computron’s Statement of Cash Flows (Millions of Dollars)
2019
Operating Activities
Net Income before preferred dividends 264$
Noncash adjustments
Chapter 2 Mini Case
Jenny Cochran, a graduate of The University of Tennessee with 4 years of experience as an equities analyst, was recently
brought in as assistant to the chairman of the board of Computron Industries, a manufacturer of computer components.
During the previous year, Computron had doubled its plant capacity, opened new sales offices outside its home territory, and
launched an expensive advertising campaign. Cochran was assigned to evaluate the impact of the changes. She began by
gathering financial statements and other data.
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c. What is free cash flow? Why is it important? What are the five uses of FCF? Answer: See Mini Case Show.
current liabilities? How much net operating working capital and total net operating capital does Computron have?
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= $750
= $580
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A B C D E F G H I
Depreciation and amortization 320
Due to changes in working capital
Net cash provided by investing activities (830)$
Financing Activities
Change in notes payable 200$
Change in long-term debt 300
Payment of cash dividends (84)
Net cash provided by financing activities 416$
Net change in cash and equivalents (10)$
Cash and securities at beginning of the year 60
Cash and securities at end of the year 50$
Net Operating Profit After Taxes
2019 NOPAT = EBIT x ( 1 – T )
= $460 x75%
= $345
2018 NOPAT = EBIT x ( 1 – T )
= $560 x75%
= $420
Net Operating Working Capital
a. (1.) What effect did the expansion have on sales and net income? Answer: See Mini Case Show.
a. (2.) What effect did the expansion have on the asset side of the balance sheet? Answer: See Mini Case Show
b. What do you conclude from the statement of cash flows? Answer: See Mini Case Show.
NOPAT is the amount of profit Computron would generate if it had no debt and held no financial assets.
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.
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= $4,250.0 $6,000
= 70.8%
= $3,480.0 $6,000
= 58.0%
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A B C D E F G H I
= $750 +$3,500
= $4,250
= $580 +$2,900
= $3,480
TNOC = NOWC + net operating long-term assets
2019 TNOC = NOWC + Fixed assets
Free Cash Flow
2019 FCF = NOPAT −Net Investment in Operating Capital
= $345.0 −$770
= -$425
Uses of FCF 2019
After-tax interest payment = $81
Return on Invested Capital
2019
ROIC =NOPAT ÷ Operating Capital
= $345.0 $4,250
= 8.1%
2018
ROIC =NOPAT ÷ Operating Capital
= $420.0 $3,480
= 12.1%
Operating Profitability
2019
OP =NOPAT ÷ Sales
= $345.0 $6,000
= 5.8%
2018
OP =NOPAT ÷ Sales
= $420.0 $6,000
= 7.0%
Capital Utilization
e. What is Computron’s free cash flow (FCF)? What are Computron’s “net uses” of its FCF?
f. Calculate Computron’s return on invested capital (ROIC). Computron has a 10% cost of capital (WACC). What caused the
decline in the ROIC? Was it due to operating profitability or capital utilization? Do you think Computron’s growth added value?
The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.
Computron’s Free Cash Flow calculation 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.
The operating profitability (OP) ratio shows how many dollars of operating profit are generated by each dollar of sales.
The capital utilization (CR) ratio shows how many dollars of operating assets are needed to generated a dollar of sales.
Operating profitability declined and the capital utlization worsened, each contributing to the big decrease in ROIC.
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federal tax liability?
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EVA = NOPAT −Operating Capital x WACC
= -$80
= $72
capital, has been deducted.
Economic Value Added
Year-end common stock price $50.00 $30.00
Year-end shares outstanding (in millions) 100 100
Market Value Added
2019
MVA = Stock price x # of shares – Total common equity
= $30.00 x100 –$2,910
= $3,000 –$2,910
= $90
2018
MVA = Stock price x # of shares – Total common equity
= $50.00 x100 –$2,730
= $5,000 –$2,730
= $2,270
Taxable vs. Tax Exempt bonds
k. The Tax Cut and Jobs Act was signed into law in 2017. Briefly describe its key provisions related to personal taxation. Answer:
See Mini Case Show.
g. What is Computron’s EVA? The cost of capital was 10% in both years.
j. Assume that a corporation has $87 million of taxable income from operations. It also received interest income of $8 million
and dividend income of $10 million. The federal tax rate is 21% and the dividend exclusion rate is 50%. What is the company’s
l. Assume that you are in the 25% marginal tax bracket and that you have $20,000 to invest. You have narrowed your
investment choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one
should you choose and why? At what marginal tax rate would you be indifferent?
i. The Tax Cut and Jobs Act was signed into law in 2017. Briefly describe its key provisions related to corporate tax taxation.
Answer: See Mini Case Show.
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.
h. What happened to Computron’s market value added (MVA)?
Economic Value Added represents Computron’s residual income that remains after the cost of all capital, including equity
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A B C D E F G H I
Amount to invest $20,000
Corporate interest rate 10%
Municipal interest rate 7%
Tax Rate 25.0%
After-tax interest
Tax rate at which you would be indifferent
After-tax yield on muni versus corp bond
Muni Yield = Corp Yield *(1-Tax rate)
Solve for T
Tax rate = 1 – (Muni yield / Corp yield)
Tax Rate = 30.00%
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J K L M N O P
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J K L M N O P
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J K L M N O P
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J K L M N O P
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J K L M N O P