Question

1. When analyzing a firm’s financial performance, should the analyst focus on the incremental after-tax profits or the incremental after-tax cash flows of the firm? Explain your reasoning!

2. Holding all else constant, how would a significant increase in interest bearing debt impact the measure of the firm’s Free Cash Flow? Explain!

3. If a firm uses an accelerated depreciation expense method (MACRS) versus straight line depreciation expense for a newly acquired asset, what would be the impact on the firm’s operating profit after taxes in the first year the asset was in use? What would be the impact on the firm’s free cash flow after taxes in the first year the asset was in use? Which method of depreciation would you recommend?

4. In 2019, the firm’s operating profit after taxes decreased significantly, however, the firm’s free cash flow increased in 2019. Assuming the firm’s depreciation expense and W/C did not change, what is a likely explanation for the set of performance measures for this firm in 2019? Based on this information, was the firm’s performance in 2019 good, bad, or unclear?

5. In 2019, the firm’s operating profit after taxes was constant, the firm’s free cash flow decreased significantly, and the firm’s EVA was constant. What is a likely explanation for the set of performance measures for this firm in 2019? Based on this information, was the firm’s performance in 2019 good, bad, or unclear?

6. What could account for the fact that the firm’s economic value added and ROIC was positive and significantly greater than their peer firm in 2019, while the firm’s abnormal stock return compared to their peer was negative in 2019?

7. In January of 2020, Ford Motor Corporation is going to announce their plans to start constructing a production facility in Kenya in the second quarter of 2020. It is expected that Ford will not begin selling cars and trucks in Kenya until the fourth quarter of 2021 (depreciation expense will not begin until the firm starts to utilize the assets in their operations). Along with the announcement to expand into Kenya, Ford announced their expectations of a very high return on invested capital from this investment opportunity. The project will be financed at the firm’s current debt to asset ratio (w_d) of around 25%. What is the likely impact of this decision for Ford’s performance in fiscal year 2020? More specifically, explain your predicted impact on the following performance measures:

Operating Margin:

Operating Return on Assets:

Free Cash Flow:

Economic Value Added:

Total Shareholders’ Return:

Answer 1

ANSWERS

1 . ANSWER

When analyzing a firm’s financial performance, should the analyst focus on the after-tax profits or the incremental after-tax cash flows of the firm

When determining which one is more important, it depends on the business and the circumstances.

For example, a business may see a profit every month, but its money is tied up in hard assets or accounts receivable, and there is no cash to pay employees. Once a debt is paid, or the business sees an influx in revenue, it starts to see positive cash flow again. In this example, cash flow is more important because it keeps the business running while still maintaining a profit. Alternately, a business may see increased revenue and cash flow, but there is a substantial amount of debt, so the business does not make a profit.

The absence of a profit eventually has a declining effect on the cash flow. In this instance, profit is more important. Another thing to remember when determining whether to focus on cash flow or profit is cash flow can be bought. A business owner can put up his or her personal assets as capital into the business. Alternatively, they can get a small business loan from a bank to keep the business running until it starts seeing cash flow again.

2 . ANSWER

Debt financing includes principal, which must be repaid to lenders or bondholders, and interest. While debt does not dilute ownership, interest payments on debt reduce free cash flow.

4 . ANSWER

Explanation for the set of performance measures for this firm in 2019 is given below

1 . Company can received an influx of cash from borrowings of a credit facility along with additional cash from new long-term debt.

2 . In other words, the company still posted a loss for the period but received enough cash from borrowing to offset the loss and create positive cash flow.

3 . Remember that the cash flow statement only shows a company's cash position. It's not a measure of profitability. A company can still post a loss in its daily operations but have cash available or cash inflows due to various circumstances.

Conclusion - Taking all the points in mind the condition of the firm is not good in 2019 .

5 . ANSWER

Explanation for the set of performance measures for this firm in 2019 is given below

This discrepancy in the measures between operating profit after tax and cash-flow is caused primarily by timing differences.

1 . To get an accurate picture of a company's profit, accounting only focuses on when the revenue is legally earned and expenses incurred (legally due), without regard to when the cash is actually exchanged. This is known as accrual accounting and is built on the matching principle (i.e. match the revenue earned with the expenses needed to earn that revenue)

2 . To get an accurate picture of a company's cash-flow, accounting only focuses on when the cash is actually exchanged (received or paid) with the legal obligations being extinguished. The profit aspect of when the revenue and expenses occurred, are not considered.

Using this simple and rather restricted example, you can see how a company can make profit but still be cash-flow negative:

A . Profit for the period = Revenue ($1,000 total sales) less expenses ($500 used reams) = positive $500 profit

B . Cash-flow for the period = Cash in ($500 cash sales) less cash out ($1,000 cash paid for reams) = negative $500 cash-flow .

Conclusion - Taking all points in mind the condition of the firm is Good in 2019 .