$11/20/2018$

Chapter $2$ Mini Case

Situation

"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."

Computron's Balance Sheets $($Millions of Dollars$)$

$20182019$

Assets

Cash and equivalents $$60$ $$50$

Short$-$term investments $10010$

Accounts receivable $400520$

Inventories $620820$

Total current assets $$1,180$ $$1,400$

Gross fixed assets $$3,900$ $$4,820$

Less: Accumulated depreciation $1,0001,320$

Net fixed assets $$2,900$ $$3,500$

Total assets $$4,080$ $$4,900$

Liabilities and equity

Accounts payable $$300$ $$400$

Notes payable $50250$

Accruals $200240$

Total current liabilities $$550$ $$890$

Long$-$term bonds $8001,100$

Total liabilities $$1,350$ $$1,990$

Common stock $1,0001,000$

Retained earnings $1,7301,910$

Total equity $$2,730$ $$2,910$

Total liabilities and equity $$4,080$ $$4,900$

Computron's Income Statement $($Millions of Dollars$)$

$20182019$

Net sales $$5,500$ $$6,000$

Cost of goods sold $($Excluding depr. & amort.$)4,3004,800$

Depreciation and amortizationa $290320$

Other operating expenses $350420$

Total operating costs $$4,940$ $$5,540$

Earnings before interest and taxes $($EBIT$)$ $$560$ $$460$

Less interest $68108$

Pre$-$tax earnings $$492$ $$352$

Taxes $(25\%)12388$

Net Income $$369$ $$264$

Notes:

a Computron has no amortization charges.

Other Data $20182019$

Stock price $$50\mathrm{.}00$ $$30\mathrm{.}00$

Shares outstanding $($millions$)100100$

Common dividends $($millions$)$ $$90$ $$84$

Tax rate $25\%25\%$

Weighted average cost of capital $($WACC$)10\mathrm{.}00\%10\mathrm{.}00\%$

Computron's Statement of Cash Flows $($Millions of Dollars$)$

$2019$

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$

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$

a$.(1.)$ What effect did the expansion have on sales and net income? $(2$ pts$)$

Sales increased from $$5,500$ to $$6,000$ in the year after the expansion, but net income decreased from $$369$ to $$264$ because of increased cost of goods sold, depreciation and ammoritization, and other operating costs increasing due to the expansion which outweighed the increase in revenue.

a$.(2.)$ What effect did the expansion have on the asset side of the balance sheet? $(2$ pts$)$

The expansion had several effects on the asset side of the balance sheet. Current assets rose from $$1,180$ to $$1,400,$ indicating more resources available for short$-$term obligations. Accounts receivable increased from $$400$ to $$520,$ suggesting higher sales on credit. Inventories increased from $$620$ to $$820,$ indicating more stock to meet anticipated demand. Cash and equivalents decreased from $$60$ to $$50,$ reflecting potential cash outflows for expansion activities. Short$-$term investments decreased from $$100$ to $$10,$ suggesting liquidation of investments to support expansion. There was an increase in gross fixed assets from $$3,900$ to $$4,820,$ reflecting the investment in doubling plant capacity. The net fixed assets increased from $$2,900$ to $$3,500,$ after accounting for accumulated depreciation.

b$.$ What do you conclude from the statement of cash flows? $(2$ pts$)$

The statement of cashflo