Question 1

‘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. (Data Attached)

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 do you conclude from the statement of cash flows?

b. 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?

c. What is Computron’s free cash flow (FCF)? What are Computron’s “net uses” of its FCF?

d. 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?

e. What is Computron’s EVA?  The cost of capital was 10% in both years.

f. Assume that a corporation has $200,000 of taxable income from operations. What is the company’s federal tax liability?

g. Assume that you are in the 25% marginal tax bracket and that you have $50,000 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?

Question 2

James Madison was brought in as assistant to Computron’s chairman, who had the task of getting the company back into a sound financial position.  Madison must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions to take. Your assignment is to help her answer the following questions, using the recent and projected financial information shown next. Provide clear explanations, not yes or no answers.

a. Why are ratios useful? What three groups use ratio analysis and for what reasons?

b. Calculate the profit margin, operating profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE).  What can you say about these ratios?

c. Calculate the inventory turnover, days sales outstanding (DSO), fixed assets turnover, operating capital requirement, and total assets turnover.  How does Computron’s utilization of assets stack up against other firms in its industry?

d. Calculate the current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity position and its trend?

e. Calculate the debt ratio, liabilities-to-assets ratio, times-interest-earned, and EBITDA coverage ratios.  How does Computron compare with the industry with respect to financial leverage?  What can you conclude from these ratios?

f. Calculate the price/earnings ratio and market/book ratio.  Do these ratios indicate that investors are expected to have a high or low opinion of the company?

g. Use the extended DuPont equation to provide a summary and overview of Computron’s projected financial condition.  What are the firm’s major strengths and weaknesses?

h. What are some potential problems and limitations of financial ratio analysis?

i. What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance?