Question

Free Cash Flows

Rhodes Corporation’s financial statements are shown below.

Rhodes Corporation: Income Statements for Year Ending December 31
(Millions of Dollars)

	2020			2019
Sales	$	11,000		$	10,000
Operating costs excluding depreciation		9,536			8,684
Depreciation and amortization		340			320
Earnings before interest and taxes	$	1,124		$	996
Less interest		260			200
Pre-tax income	$	864		$	796
Taxes (25%)		216			199
Net income available to common stockholders	$	648		$	597
Common dividends	$	205		$	200

Rhodes Corporation: Balance Sheets as of December 31 (Millions of Dollars)

	2020			2019
Assets
Cash	$	550		$	500
Short-term investments		230			200
Accounts receivable		2,750			2,500
Inventories		1,450			1,200
Total current assets	$	4,980		$	4,400
Net plant and equipment		3,650			3,500
Total assets	$	8,630		$	7,900
Liabilities and Equity
Accounts payable	$	1,100		$	1,000
Accruals		550			500
Notes payable		190			100
Total current liabilities	$	1,840		$	1,600
Long-term debt		1,100			1,000
Total liabilities	$	2,940			2,600
Common stock		4,347			4,400
Retained earnings		1,343			900
Total common equity	$	5,690		$	5,300
Total liabilities and equity	$	8,630		$	7,900

Suppose the federal-plus-state tax corporate tax is 25%. Answer the following questions.

1. What are the amounts of total net operating capital for both years? Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.

2020: $   million

2019: $ million

2. What is the free cash flow for 2020? Enter your answer in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Cash outflow, if any, should be indicated by a minus sign. Round your answer to the nearest whole number.

$ million

3. What is the ROIC for 2020? Round your answer to two decimal places.
4. How much of the FCF did Rhodes use for each of the following purposes: after-tax interest, net debt repayments, dividends, net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative.) Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.

After-tax interest payment	$ million
Reduction (increase) in debt	$ million
Payment of dividends	$ million
Repurchase (Issue) stock	$ million
Purchase (Sale) of short-term investments	$million

Answer 1

a. What are the amounts of total net operating capital for both years? Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.

2020: $   million

2019: $ million

ANSWER

Compute the total net operating capital (NOC), using the equation as shown below:

Year 2019:

NOC = NOWC + Net fixed assets

         = $2,600 + $3,500

         = $6,100

Hence, the NOC is $6,100 million.

Compute the total net operating capital (NOC), using the equation as shown below:

Year 2020:

NOC = NOWC + Net fixed assets

         = $2,910 + $3,650

         = $6,560

Hence, the NOC is $6,560 million.

WORKING

Compute the net operating working capital (NOWC), using the equation as shown below:

Year 2019

NOWC = Cash + Accounts receivables + Inventories – Accounts payables – Notes payables – Accruals

             = $500 + $2,500 + $1,200 - $1,000 - $100 - $500

             = $2,600

Hence, the NOWC is $2,600 million.

Year 2020

NOWC = Cash + Accounts receivables + Inventories – Accounts payables – Notes payables – Accruals

             = $550 + $2,750 + $1,450 - $1, 100 - $190 - $550

             = $2,910

Hence, the NOWC is $2,910 million.

b) What is the free cash flow for 2020? Enter your answer in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Cash outflow, if any, should be indicated by a minus sign. Round your answer to the nearest whole number.

$ million

ANSWER

Compute the free cash flow (FCF) for the year 2020, using the equation as shown below:

FCF = NOPAT + Depreciation – Change in NOC – Change in short term investment

        = $843 + $340 – ($6,560 - $6,100) – ($230 - $200)

       = $843 + $340 - $460 - $30

        = $693 million

Hence, the FCF for the year 2020 is $693 million.

WORKING

NOPAT = Earnings before interest and taxes*(1 – Tax rate)

              = $1,124*(1 – 0.25)

       = $843 million

Hence, the NOPAT is $843 million.   

c) What is the ROIC for 2020? Round your answer to two decimal places.

ROIC=NOPAT/Total Net operating capital

ROIC=843/6560

ROIC=12.8%

d) How much of the FCF did Rhodes use for each of the following purposes: after-tax interest, net debt repayments, dividends, net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative.) Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.

After-tax interest payment	$ million
Reduction (increase) in debt	$ million
Payment of dividends	$ million
Repurchase (Issue) stock	$ million
Purchase (Sale) of short-term investments	$million

AFTER TAX INTEREST PAYMENT	195
REDUCTION(INCREASE) IN DEBT	190
PAYMENT OF DIVIDENDS	205
REPURCHASE(ISSUE) STOCK	53
PURCHASE(SALE) SHORT TERM INVESTMENT	30

WORKING NOTES

AFTER TAX INTEREST PAYMENT=INTEREST*( 1-T)

AFTER TAX INTEREST PAYMENT=260*( 1-.25)

AFTER TAX INTEREST PAYMENT=195 MILLION

REDUCTION(INCREASE) IN DEBT=INCREASE IN NOTE PAYABLE+INCREASE IN LT DEBT

INCREASE IN DEBT=(190-100)+( 1100-1000)

INCREASE IN DEBT=90+ 100

INCREASE IN DEBT=190 MILLION

REPURCHASE OF STOCK=4347-4400

REPURCHASE STOCK=53 MILLION

PURCHASE OF SHORT TERM INVESTMENT=230-200

PURCHASE OF SHORT TERM INVESTMENT=30 MILLION