Chapter 3 Lecture Hand-outs - Problem Solving

8/9/2019 Chapter 3 Lecture Hand-outs - Problem Solving

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Fin Man 1, Chapter 3 Lecture Hand-outs

Free Cash Flow Business Analysis

A group of investors is considering buying the Wheelwright Corporation, but does not want to

contribute to the companys nancial support after the purchase. Wheelwrights management

has oered the following nancial statements covering last year (! omitted"#

Income Statement Balance Sheets

$eginning %ndingA&&%'&

&ales )) Cash * +

C-& /0 Accts 1eceivable / 2)

Depreciation 6 Inventory 12 7-ross !argin *) Current Assets / /*

Expenses 25 Fixed AssetsEBIT 5 !ross 1"" 115Interest 7 Acc#m Deprec $12% $1&%EBT 2& 'et Fixed Assets && (7Tax &

'et Income 2" Total Assets 11( 1Cost of -oods &old

34A$434'4%& 5 %674'8

Accts 9ayable : 2

Accr#als 6 & )#rrent *ia+ilities 2 2(De+t 71 5(

E,#ity 25 -5 Total *ia+ilities

. E,#ity 11( 1

Wheelwright paid no dividends and sold no new stoc; during the year. 'he rms ta< rate is

/)=.

REQUIRED: a. >evelop Wheelwrights free cash ?ow and ma;e a recommendation as to

whether it seems to be an appropriate ac@uisition for the investors.

b. Assume that the investors will purchase the company subect to its e


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FCF % peratin. Cash F/o0 4 Increase in Fi5ed $ssets - Increase in Current

$ccounts

% )3+* - )1* - )1 % )1+*

&ince free cash ?ow is substantially positive and the potential buyers are not interested in

further investment, it seems that Wheelwright is an appropriate ac@uisition candidate.

b. Consideration of servicing Wheelwrights debt leads to a concept ;nown as free cash?ow to e@uity (DCD%". 'his is what remains for stoc;holders after the rm uses cash to pay

interest and ma;e any payments re@uired to reduce principal. &ince interest is deductible, we

can consider its cash ?ow implications after ta< by multiplying by (F'".

4nterest after ta< G 4nterest (F'" G : (F./" G 0.+

&ubtracting that from free cash ?ow implies that Wheelwright generates almost )! per

year thats available to pay o debt andHor distribute to shareholders. 7nless the debt

re@uires unusually large principal payments in the short run, the rm still appears to meet the

investors re@uirements

Common Size Statements

*inden )orp/ has a 1"0 maret share in its ind#stry/ Belo are income statements $34% or *inden and or theind#stry/

*inden Ind#strySales 36""" 36-""")ost o !oods Sold 2"" 65"!ross 4arin 2&"" "5"

Expenses8 Sales and 4aretin -" &5" Enineerin 225 265" Finance and Administration 65" -56"Total Expenses 1"5 11"6"

EBIT 1-(5 1(2("Interest Expense 2" -5""EBT 1265 1-7("Tax 5"" 562"

'et Income 765 (17"

REQUIRED:

Develop common si9ed income statements or *inden and the ind#stry as a hole/

SOLUTION:

*inden 0 Ind#stry 0Sales 36""" 1""/" 36-""" 1""/")ost o !oods Sold 2"" 5/ 65" 52/6!ross 4arin 2&"" -7/7 "5" -7/-Expenses8 Sales and 4aretin -" 7/2 &5" 6/" Enineerin 225 /& 265" -/1 Finance and Administration 65" 1"/& -56" 7/1Total Expenses 1"5 21/& 11"6" 17/2

9repared by# 3uEE $. 3andicho, C9A, !$ADaculty, College of Accountancy 5 %conomics, 93!9age of *


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EBIT 1-(5 2-/( 1(2(" "/1Interest Expense 2" /& -5"" 7/"EBT 1265 21/1 1-7(" 2/1Tax 5"" &/ 562" &/&

'et Income 765 12/& (17" 1-/

RATIO ANALYSIS

Axtel )ompany has the olloin inancial statements8

In addition Axtel retiredstoc or 31"""""" and paid a dividend o 31727"""/ Depreciation or theyear as 31166"""/ )onstr#ct a Statement o )ash Flos or Axtel or 2""1/ $Hint8 :etirin stoc means +#yin it

+ac rom shareholders/ Ass#me the p#rchase as made at +oo val#e and treat it lie a neative sale o stoc/%

REQUIRED:

)alc#late all o the ratios disc#ssed in the chapter or the Axtel )ompany o pro+lem 5/ Ass#me Axtel had leasincosts o 37267 in 2";1 and had 126&""" shares o stoc o#tstandin that ere val#ed at 32&/75 per share at yearend/

SOLUTION:

9repared by# 3uEE $. 3andicho, C9A, !$ADaculty, College of Accountancy 5 %conomics, 93!9age 3of *


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Current Ratio

)#rrent Assets < )#rrent *ia+ilities = 31167& < 3211" = 5/5

Qui! Ratio

>)#rrent Assets

Inventory? < )#rrent *ia+ilities= $31167&

322"% < 3211" = -/"

A"era#e Colletion $erio% &AC$'

>Accts :ec < Sales? 6" = >$355& < 36227% 6"?

= 55/5 days

In"entory Turno"er

)@!S < Inventory = 31((25 < 322" = 6/2

@:

Sales < Inventory = 36227 < 322" = 11/

Fi(e% Asset Turno"er

Sales < Fixed Assets = 36227 < 311"-7 = /

Total Asset Turno"er

Sales < Total Assets = 36227 < 322725 = 1/6

)e*t Ratio

>*on Term De+t )#rrent *ia+ilities? < Total Assets = $36""2 3211"% < 322725 = 5/70

)e*t to +,uity Ratio

*on Term De+t8 E,#ity = 36""2 8 31-61 = /-181

Times Interest +arne% &TI+'

EBIT < Interest = 35-- < 371 = 7/6

Cash Co"era#e

>EBIT Depreciation? < Interest = $35-- 31166% < 371 = (/

Fi(e% Char#e Co"era#e

>EBIT *ease ayments? < >Interest *ease ayments? = $35-- 37267% < $371 37267%

= 1/6

Return on Sales

9repared by# 3uEE $. 3andicho, C9A, !$ADaculty, College of Accountancy 5 %conomics, 93!9age of *


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'et Income < Sales = 3116 < 36227 = &/60

Return on Assets

'et Income < Total Assets = 3116 < 322725 = 1/70

Return on +,uity

'et Income < E,#ity = 3116 < 31-61 = 21/0

$rie +arnin#s Ratio &$-+'

First calc#late the Earnins per Share $ES%

ES = 'et Income < C shares o#tstandin= 3116 < 1/26& million= 32/-6

Then

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Chapter 3 Lecture Hand-outs - Problem Solving