This is a Collaborative Learning Community (CLC) assignment.
Read the (Integrative Case 2) in your textbook and answer Questions a-g at the end of the case. The case is cumulative and incorporates concepts learned throughout the course. Keep the following in mind as your complete the assignment:
In Question b, calculate EPS for each year 2009-2015.
In Question d, make sure to include each ratio listed in Table 5 of the case for both 2014 and 2015. You will have to calculate the 2015 ratio values.
For Question d, you are required to write an evaluation of each area of performance as part of your answer. Merely citing numerical ratio values will not earn full credit.
Note that your answers for Questions f and g do not necessarily match.
Answer all questions on an Excel spreadsheet using the same guidelines for spreadsheet development used for your homework assignments. See “Guidelines for Developing Spreadsheets” for a full description of additional requirements.
Submit a single spreadsheet file for this assignment, do not submit multiple files.
Answer each question on a different spreadsheet tab.
Label all numbers, both variables and the final answer.
Use the yellow highlighter on Excel’s top menu bar to highlight your final answer.
This assignment uses a rubric. Please review the rubric prior to beginning the assignment to become familiar with the expectations for successful completion.
Track Software, Inc.Seven years ago, after 15 years in public accounting, Stanley Booker, CPA,resigned his position as manager of cost systems for Davis, Cohen, and O’BrienPublic Accountants and started Track Software, Inc. In the 2 years preceding hisdeparture from Davis, Cohen, and O’Brien, Stanley had spent nights and weekendsdeveloping a sophisticated cost-accounting software program that became Track’sinitial product offering. As the firm grew, Stanley planned to develop and expandthe software product offerings, all of which would be related to streamlining theaccounting processes of medium- to large-sized manufacturers.Although Track experienced losses during its first 2 years of operation—2009and 2010—its profit has increased steadily from 2011 to the present (2015). Thefirm’s profit history, including dividend payments and contributions to retainedearnings, is summarized in Table 1.Stanley started the firm with a $100,000 investment: his savings of $50,000 asequity and a $50,000 long-term loan from the bank. He had hoped to maintain hisinitial 100 percent ownership in the corporation, but after experiencing a $50,000loss during the first year of operation (2009), he sold 60 percent of the stock to agroup of investors to obtain needed funds. Since then, no other stock transactionshave taken place. Although he owns only 40 percent of the firm, Stanley activelymanages all aspects of its activities; the other stockholders are not active in managementof the firm. The firm’s stock was valued at $4.50 per share in 2014 and at$5.28 per share in 2015.
Track Software, Inc., Profit, Dividends, and Retained Earnings, 2009–2015
Year Net profits after taxes (1) Dividends paid (2) Contribution to retained earnings [(1) − (2)] (3)
2009 ($50,000) $ 0 ($50,000)2010 (20,000) 0 (20,000)2011 15,000 0 15,0002012 35,000 0 35,0002013 40,000 1,000 39,0002014 43,000 3,000 40,0002015 48,000 5,000 43,000
Stanley has just prepared the firm’s 2015 income statement, balance sheet, andstatement of retained earnings, shown in Tables 2, 3, and 4, along with the 2014balance sheet. In addition, he has compiled the 2014 ratio values and industryaverage ratio values for 2015, which are applicable to both 2014 and 2015 andare summarized in Table 5. He is quite pleased to have achieved record earnings of$48,000 in 2015, but he is concerned about the firm’s cash flows. Specifically, heis finding it more and more difficult to pay the firm’s bills in a timely manner andgenerate cash flows to investors, both creditors and owners. To gain insight intothese cash flow problems, Stanley is planning to determine the firm’s 2015 operatingcash flow (OCF) and free cash flow (FCF).Stanley is further frustrated by the firm’s inability to afford to hire a softwaredeveloper to complete development of a cost estimation package that is believedto have “blockbuster” sales potential. Stanley began development of this package2 years ago, but the firm’s growing complexity has forced him to devote more ofhis time to administrative duties, thereby halting the development of this product.Stanley’s reluctance to fill this position stems from his concern that the added$80,000 per year in salary and benefits for the position would certainly lower thefirm’s earnings per share (EPS) over the next couple of years. Although the project’ssuccess is in no way guaranteed, Stanley believes that if the money were spent to hirethe software developer, the firm’s sales and earnings would significantly rise oncethe 2- to 3-year development, production, and marketing process was completed.With all these concerns in mind, Stanley set out to review the various data todevelop strategies that would help ensure a bright future for Track Software. Stanleybelieved that as part of this process, a thorough ratio analysis of the firm’s 2015results would provide important additional insights.
Track Software, Inc., Income Statement ($000) for the Year Ended December 31, 2015
Sales revenue $ 1,550 Less: Cost of goods sold Gross profits Less: Operating expenses Selling expense $ 150 General and administrative expenses 270 Depreciation expense Total operating expense Operating profits (EBIT) $ 89 Less: Interest expense Net profits before taxes $ 60 Less: Taxes (20%) Net profits after taxes
Track Software, Inc., Balance Sheet ($000)
Cash $ 12 $ 31 Marketable securities 66 82 Accounts receivable 152 104 Inventories Total current assets Gross fixed assets $195 $180 Less: Accumulated depreciation Net fixed assets Accounts payable $136 $126 Notes payable 200 190 Accruals Total current liabilities $363 $341 Long-term debt Total liabilities Common stock (50,000 shares outstanding at $0.40 par value) $ 20 $ 20 Paid-in capital in excess of par 30 30 Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
Track Software, Inc., Statement of Retained Earnings ($000) for the Year Ended December 31, 2015
Retained earnings balance (January 1, 2015) $ 59 Plus: Net profits after taxes (for 2015) 48 Less: Cash dividends on common stock (paid during 2015) Retained earnings balance (December 31, 2015)
Current ratio 1.06 1.82Quick ratio 0.63 1.10Inventory turnover 10.40 12.45Average collection period 29.6 days 20.2 daysTotal asset turnover 2.66 3.92Debt ratio 0.78 0.55Times interest earned ratio 3.0 5.6Gross profit margin 32.1% 42.3%Operating profit margin 5.5% 12.4%Net profit margin 3.0% 4.0%Return on total assets (ROA) 8.0% 15.6%Return on common equity (ROE) 36.4% 34.7%Price/earnings (P/E) ratio 5.2 7.1Market/book (M/B) ratio 2.1 2.2
TO DOa. (1) On what financial goal does Stanley seem to be focusing? Is it the correctgoal? Why or why not?(2) Could a potential agency problem exist in this firm? Explain.b. Calculate the firm’s earnings per share (EPS) for each year, recognizing that thenumber of shares of common stock outstanding has remained unchanged sincethe firm’s inception. Comment on the EPS performance in view of your responsein part a.c. Use the financial data presented to determine Track’s operating cash flow (OCF)and free cash flow (FCF) in 2015. Evaluate your findings in light of Track’s currentcash flow difficulties.d. Analyze the firm’s financial condition in 2015 as it relates to (1) liquidity, (2) activity,(3) debt, (4) profitability, and (5) market, using the financial statementsprovided in Tables 2 and 3 and the ratio data included in Table 5. Be sure toevaluate the firm on both a cross-sectional and a time-series basis.e. What recommendation would you make to Stanley regarding hiring a new softwaredeveloper? Relate your recommendation here to your responses in part a.f. Track Software paid $5,000 in dividends in 2015. Suppose that an investor approachedStanley about buying 100% of his firm. If this investor believed that byowning the company he could extract $5,000 per year in cash from the companyin perpetuity, what do you think the investor would be willing to pay for the firmif the required return on this investment is 10%?g. Suppose that you believed that the FCF generated by Track Software in 2015could continue forever. You are willing to buy the company in order to receivethis perpetual stream of free cash flow. What are you willing to pay if you requirea 10% return on your investment?