1. 2 - 1 Balance Sheet is “Stock” (as of) Other Statements are “Flow” (through time) When analyzing, keep “unusual events” in mind” NOTES

2. 2 - 2 What effect did the expansion have on net operating working capital (NOWC)? NOWC 98 = ($7,282 + $632,160 + $1,287,360) - ($524,160 + $489,600) = $913,042. NOWC 97 = $793,800. = - Non- interest bearing CA Non- interest bearing CL NOW C

3. 2 - 3 What effect did the expansion have on capital used in operations? = NOWC + Net fixed assets. = $913,042 + $939,790 = $1,852,832. = $1,138,600. Operating capital 98 Operating capital 97 Operating capital

4. 2 - 4 Did the expansion create additional net operating profit after taxes (NOPAT)? NOPAT = EBIT(1 - Tax rate) NOPAT 98 = -$690,560(1 - 0.4) = -$690,560(0.6) = -$414,336. NOPAT 97 = $125,460.

5. 2 - 5 What is your initial assessment of the expansion’s effect on operations? 1998 1997 Sales$5,834,400 $3,432,000 NOPAT($414,336)$125,460 NOWC$913,042 $793,800 Operating capital$1,852,832 $1,138,600

6. 2 - 6 What effect did the company’s expansion have on its net cash flow and operating cash flow? NCF 98 = NI + DEP= - $519,936 + $116,960 = -$402,976. NCF 97 = $87,960 + $18,900 = $106,860. OCF 98 = NOPAT + DEP = -$414,336 + $116,960 = -$297,376. OCF 97 = $125,460 + $18,900 = $144,360.

7. 2 - 7 What was the free cash flow (FCF) for 1998? FCF = NOPAT - Net capital investment = -$414,336 - ($1,852,832 - $1,138,600) = -$414,336 - $714,232 = -$1,128,568. How do you suppose investors reacted?

8. 2 - 8 What is the company’s EVA? Assume the firm’s after-tax cost of capital (COC) was 11% in 1997 and 13% in 1998. EVA 98 = NOPAT- (COC)(Capital) = -$414,336 - (0.13)($1,852,832) = -$414,336 - $240,868 = -$655,204. EVA 97 = $125,460 - (0.11)($1,138,600) = $125,460 - $125,246 = $214.

9. 2 - 9 Would you conclude that the expansion increased or decreased MVA? MVA = -. During the last year stock price has decreased 73%, so market value of equity has declined. Consequently, MVA has declined. Equity capital supplied Market value of equity

10. 2 - 10 Probably not. A/P increased 260% over the past year, while sales increased by only 70%. If this continues, suppliers may cut off trade credit. Does the company pay its suppliers on time?

11. 2 - 11 No, the negative NOPAT shows that the company is spending more on it’s operations than it is taking in. Does it appear that the sales price exceeds the cost per unit sold?

12. 2 - 12 1.The company offers 60-day credit terms. The improved terms are matched by its competitors, so sales remain constant. What effect would each of these actions have on the cash account? A/R would  Cash would 

13. 2 - 13 2.Sales double as a result of the change in credit terms. Short-run: Inventory and fixed assets  to meet increased sales. A/R , Cash . Company may have to seek additional financing. Long-run: Collections increase and the company’s cash position would improve.

14. 2 - 14 The expansion was financed primarily with external capital. The company issued long-term debt which reduced its financial strength and flexibility. How was the expansion financed?

15. 2 - 15 Would external capital have been required if they had broken even in 1998 (Net income = 0)? Yes, the company would still have to finance its increase in assets.

16. 2 - 16 What happens if fixed assets are depreciated over 7 years (as opposed to the current 10 years)? No effect on physical assets. Fixed assets on balance sheet would decline. Net income would decline. Tax payments would decline. Cash position would improve.

17. 2 - 17 Other policies that affect financial statements Inventory valuation methods. Capitalization of R&D expenses. Policies for funding the company’s retirement plan.

18. 2 - 18 Does the company’s positive stock price ($2.25), in the face of large losses, suggest that investors are irrational? Common stock has limited liability. Therefore, it can never have a negative value. If it is expected to produce future cash flows, it will have a positive value.

19. 2 - 19 Why did the stock price fall after the dividend was cut? Management was “signaling” that the firm’s operations were in trouble. The dividend cut lowered investors’ expectations for future cash flows, which caused the stock price to decline.

20. 2 - 20 What were some other sources of financing used in 1998? Selling financial assets: Short term investments decreased by $48,600. Bank loans: Notes payable increased by $520,000. Credit from suppliers: A/P increased by $378,560. Employees: Accruals increased by $353,600.

21. 2 - 21 What is the effect of the $346,624 tax credit received in 1998. This suggests the company paid at least $346,624 in taxes during the past 2 years. If the payments over the past 2 years were less than $346,624 the firm would have had to carry forward the amount of its loss that was not carried back. If the firm did not receive a full refund its cash position would be even worse.

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