Mini Case: 2 – 12
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. Note: these are available in the file Ch02 Tool Kit.xlsx in
the Mini Case tab.
Balance Sheets
2018
2019
Assets
Cash and equivalents
$ 60
$ 50
Short-term investments
100
10
Accounts receivable
400
520
Inventories
620
820
Total current assets
$ 1,180
$ 1,400
Gross fixed assets
$ 3,900
$ 4,820
Less: Accumulated depreciation
1,000
1,320
Net plant and equipment
$ 2,900
$ 3,500
Total assets
$ 4,080
$ 4,900
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
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
Mini Case: 2 – 13
Income Statement
2018
2019
Net sales
$ 5,500
Cost of goods sold (Excluding depr. & amort.)
4,300
Depreciation and amortizationa
290
Other operating expenses
350
Total operating costs
$ 4,940
Earnings before interest and taxes (EBIT)
$ 560
$ 460
Less interest
68
108
Pre-tax earnings
$ 492
$ 352
Taxes (25%)
123
88
Net Income
$ 369
$ 264
Notes:
aComputron has no amortization charges.
Other Data
2018
2019
Stock price
$50.00
$30.00
Shares outstanding
Common dividends
Tax rate
Weighted average cost of capital (WACC)
Mini Case: 2 – 14
Statement of Cash Flows
2019
Operating Activities
Net Income before preferred dividends
$ 264
Noncash adjustments
Depreciation and amortization
320
Due to changes in working capital
Change in accounts receivable
(120)
Change in inventories
(200)
Change in accounts payable
100
Change in accruals
40
Net cash provided by operating activities
$ 404
Investing activities
Cash used to acquire fixed assets
$ (920)
Change in short-term investments
90
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
Cash and securities at beginning of the year
60
Cash and securities at end of the year
$ 50
a. What effect did the expansion have on sales and net income? What effect did the
expansion have on the asset side of the balance sheet? What effect did it have on
liabilities and equity?
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b. What do you conclude from the statement of cash flows?
Answer: Net CF from operations was positive, but was dragged down by a large net increase in
c. What is free cash flow? Why is it important? What are the five uses of FCF?
Answer: FCF is the amount of cash available from operations for distribution to all investors
(including stockholders and debtholders) after making the necessary investments to
support operations. A company’s value depends upon the amount of FCF it can
generate.
1. Pay interest on debt.
d. What is Computron’s 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 have?
Answer: NOPAT = EBIT(1 – TAX RATE)
Current year:
NOPAT = 460(1 – 0.25)
= $345.
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e. What is Computron’s free cash flow (FCF)? What are Computron’s “net uses” of
its FCF?
Answer: FCF = NOPAT – Net investment in capital
= $345 – ($4,250 – $3,480)
= $345 – $770
= -$425.
Uses of FCF:
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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?
ANSWER: ROIC = NOPAT / TOTAL NET OPERATING CAPITAL.
Current year:
ROIC = $345 / $4,250
= 8.1%.
Previous year:
ROIC = 12.1%.
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g. Cochran also has asked you to estimate Computron’s EVA. She estimates that the
after-tax cost of capital was 10 percent in both years.
ANSWER: EVA = NOPAT- (WACC)(CAPITAL).
h. What happened to Computron’s market value added (MVA)?
Answer: MVA = market value of the firm – book value of the firm.
Market value = (# shares of stock)(price per share) + value of debt.
Book value = total common equity + value of debt.
Mini Case: 2 – 19
i. The Tax Cut and Jobs Act (TCJA) was signed into law in 2017. Briefly describe
its key provisions for corporate taxes.
Answer: The Tax Cut and Jobs Act (TCJA) made major changes to corporate taxes. The
changes will remain in place until Congress passes a new tax bill. Following are
explanations for some of the TCJA’s major changes and features.
Corporate tax code:
1. The U.S. corporate tax code has a 21% flat rate that is fixed for corporate
payers. It does not go up as taxable income increases. The previous top rate was
Mini Case: 2 – 20
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 its
taxable income and federal tax liability?
Answer: Calculation of the company’s tax liability:
Taxable dividend income = Dividends(1 – Exclusion rate)
= $10(1 – 0.5)
= $5.
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k. Briefly describe the TCJA’s key provisions for personal taxes.
Answer: The TCJA specifies the previous tax code for personal taxes is suspended and that
TCJA’s changes to personal taxes are for 2018-2025, after which they expire and the
personal tax code reverts to its pre-TCJA form. Following are explanations for some
of the TCJA’s major changes and features.
Personal tax code:
1. There are still seven brackets, but the bracket thresholds are reduced from
previous levels. In addition, the marginal tax rates for some of the brackets have
been reduced, with the top rate decreasing from 37% to 35%. The previous top
rate was 39.6%
2. Personal exemptions are eliminated.
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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?
Answer: After-tax return income at T = 25%:
After-tax interest on corporate bond = 0.10($20,000) – (0.25)(0.10)($20,000) = $2,000
– $500 = $1,500.