2-1
NOTES
Balance Sheet is “Stock” (as of)
Other Statements are “Flow”
(through time)
When analyzing, keep “unusual
events” in mind”
2-2
What effect did the expansion have
on net operating working capital
(NOWC)?
NonNonNOW =
interest
interest
C
bearing CA bearing CL
NOWC98 = ($7,282 + $632,160 +
$1,287,360)
- ($524,160 + $489,600)
= $913,042.
NOWC97 = $793,800.
2-3
What effect did the expansion have
on capital used in operations?
Operating
capital = NOWC + Net fixed assets.
Operating
= $913,042 + $939,790
capital98
= $1,852,832.
Operating
= $1,138,600.
capital97
2-4
Did the expansion create additional
net operating profit after taxes
(NOPAT)?
NOPAT = EBIT(1 - Tax rate)
NOPAT98
= -$690,560(1 - 0.4)
= -$690,560(0.6)
= -$414,336.
NOPAT97= $125,460.
2-5
What is your initial assessment of
the expansion’s effect on
operations?
Sales
NOPAT
NOWC
1998
1997
$5,834,400 $3,432,000
($414,336)
$125,460
$913,042
$793,800
Operating capital$1,852,832 $1,138,600
2-6
What effect did the company’s
expansion have on its net cash flow
and operating cash flow?
NCF98
= NI + DEP
=$519,936 + $116,960
NCF97 = -$402,976.
$87,960 + $18,900 =
$106,860.
OCF
= NOPAT + DEP
98
= -$414,336 + $116,960
= -$297,376.
OCF97 = $125,460 + $18,900
= $144,360.
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?
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.
EVA98 = NOPAT- (COC)(Capital)
= -$414,336 (0.13)($1,852,832)
= -$414,336 - $240,868
= -$655,204.
EVA97 = $125,460 - (0.11)($1,138,600)
= $125,460 - $125,246
= $214.
2-9
Would you conclude
that the expansion increased or
decreased MVA?
Market value Equity capital
MVA = of equity supplied .
During the last year stock price
has decreased 73%, so market
value of equity has declined.
Consequently, MVA has declined.
2 - 10
Does the company pay its suppliers
on time?
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.
2 - 11
Does it appear that the sales price
exceeds the cost per unit sold?
No, the negative NOPAT shows
that the company is spending
more on it’s operations than it
is taking in.
2 - 12
What effect would each of these
actions have on the cash account?
1. The company offers 60-day credit
terms. The improved terms are
matched by its competitors, so
sales remain constant.
A/R would 
Cash would 
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.
2 - 14
How was the expansion financed?
The expansion was financed
primarily with external capital.
The company issued long-term
debt which reduced its financial
strength and flexibility.
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.
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.
2 - 17
Other policies that
affect financial statements
Inventory valuation methods.
Capitalization of R&D expenses.
Policies for funding the
company’s retirement plan.
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.
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.
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.
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.
2 - 22
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