Question

Part I: Reporting and Financial Statement Analysis

Given the following financial statements for Voice-Soft, a voice recognition company, answer the questions on the next page.

Income Statement for years
	2010	2009
Sales	$5,500	$5,000
Operating Costs excluding Depreciation and Amortization	4,675	4,250
EBITDA	825	750
Depreciation and Amortization	190	180
EBIT	$635	$570
Interest Expense	62	50
EBT	$573	$520
Taxes (40%)	229	208
NI	$344	$312

Balance Sheet for years ending December 31
	2010	2009
Assets:
Cash	$275	$250
Short Term Investments	55	50
Accounts Receivable	1,375	1,250
Inventories	825	750
Total Current Assets	$2,530	$2,300
Net Plant and Equipment	1,925	1,750
Total Assets	$4,455	$4,050
Liabilities:
Notes Payable	$192	$100
Accounts Payable	580	500
Miscellaneous Payables	245	250
Total Current Liabilities	$1,017	$850
Long-Term Debt	550	500
Total Liabilities	$1,567	$1,350
Common Stock	2154	2,200
Retained Earnings	734	500
Less Treasury Stock	46	0
Total Shareholder Equity	$2,888	$2,700
Liabilities and Shareholder Equity	$4,455	$4,050

Cash Flow Statement for year ending December 31, 2010
Operating Activities
Net Income	$344
Depreciation and Amortization	190
Increase in Accounts Receivables	(125)
Increase in Inventories	(75)
Increase in Accounts Payables	80
Decrease in Miscellaneous Payables	(5)
Net Cash Provided by Operations	409
Investing Activities
Purchase of equipment	(365)
Increase in Short Term Investments	(5)
Net Cash Used for Investment Activities	(370)
Financing Activities
Dividends paid	(110)
Increase in Notes Payable	92
Increase in Long Term Debt	50
Purchase stock for Treasury	(46)
Net Cash used for Financing Activities	(14)
Beginning Cash Balance January 1, 2010	250
Ending Cash Balance December 31, 2010	275
Net Cash Flow	$25

Develop Free Cash Flow for 2010 from the income statement, balance sheet and cash flow statement above.

FCF=(NOPAT+D&A) –(investment in fixed assets + change in net operating working capital)

Develop and analyze the results of an extended DuPont equation based on 2009 and 2010.

ROE= return on sales * total asset turnover * equity multiplier = NI/slaes * sales/total asset * total asset/ shareholder equty

Part II: Capital Budgeting and Uses of Financial Statements

Voice-Soft Inc. is trying to determine whether to open a new product line, Voice-Write, a speech-to-text product, which is expected to be competitive for four years. The cost of the new capital equipment including shipping and installation is $3100. The equipment will last for 4 years. They use simple straight line depreciation and the market value of the equipment at the end of the project (or it’s salvage value) is $400. For 2013 to 2016, sales are expected to be $4000, 4000, 4200, and 4200; and operating expenses, $2800, $2800, $2700, $2700. The company is expecting to lose before tax operating income of $200 per year due to Voice-Write cannibalizing its current product, Voice-Speak. Voice-Soft has a tax rate of 40% and a weighted average cost of capital (WACC) of 12%.

Complete the Project cash flow statement below and then answer questions 2 -4.

	2012	2013	2014	2015	2016
Sales
Operating Expenses
Opportunity Costs
Depreciation
Operating Income (EBIT)
Taxes
Operating Income after taxes
Depreciation
Cash Flow
Salvage Value
Salvage Tax
Net Salvage Value
Initial capital Investment
Project Cash Flow

Determine the Net Present Value.

Determine the IRR.

Should Voice-Soft make the investment and why? Explain any limitations or concerns you may have about the acceptance or rejection of this project.

What impact does acceptance or rejection of this project have on the value of Voice-Soft as a firm and on Voice-Soft’s stock? Explain.

Answer 1

PART I ----- Free Cash Flow (FCF) for 2010 =( NOPAT + Dep & Amort ) -(inv in F.A + changes in net W.C); EBIT for 2010 = 635 = Net operating profit after tax = 344; NOPAT + Dep & Amort = 344+190= 534; inv in F.A = 1925. changes in net w.capital in 2010 = Current assets - current liabilities = 2530 -1017 = 1413; Hence FCF for 2010 = 534 - (1925 +1413)= - 2804 Hence there is a negative cash flow.

Based on Du Pont equation : Return on Equity = Net income/Shareholder's equity. For 2009 : ROE = 312/2700 *100 = 11.56% ; For 2010 ROE= 344/2888*100 = 11.91%

PART II ------- Year 2012 :- initial investment = 3100 ; Y 2013 , 2014, 2015, 2016 = Sales = 4000,4000,4000,4200 respectively. operating exp = 2800,2800,2700,2700 respectively ; Opportunity expenses = 200 for each 4 years. Depreciation = 3100-400/4 =675 ; HENCE Operating income which is EBIT = 325 each for 2013, 2014 & 625 each for 2015, 2016. Tax is 40% . Hence operating income after tax is 195 for both 2013,2014 & operating income is 375 each for 2015,2016. HENCE PROJECTED CASH FLOW FOR 2013 = 870 ; PROJECTED CASH FLOW FOR 2014 = 870; PROJECTED CASH FLOW FOR 2015 = 1050 and PROJECTED CASH FLOW FOR 2016 = 1290. Hence Value of the firm = Projected Cash flow in total/[1+wacc *(1-tax rate)]^4 = 4080/1.072^4 = 4080/1.321=3088.6. Now a $100 at[ (12%*60% = 7.2%] discount rate will make 132.06 at the end of 4 years. HENCE NPV of the project = 3088.6/132.06*100 = 2338.79

There is a positive cash flow and hence the voice soft should make the investment.

IRR is a discounting rate at which NPV is assumed to be zero. IRR = R1% + NPV1 *(R2-R1)%/NPV1-NPV2.

At R1= 7.2% NPV1 = 2339; At R2 = 12% ; NPV 2 = 3088.6/157.35*100= 1963. Hence, IRR = 29.87%