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	$	12,000		$	10,000
Operating costs excluding depreciation		10,524			8,658
Depreciation and amortization		400			370
Earnings before interest and taxes	$	1,076		$	972
Less interest		120			100
Pre-tax income	$	956		$	872
Taxes (25%)		239			218
Net income available to common stockholders	$	717		$	654
Common dividends	$	203		$	200

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

	2020			2019
Assets
Cash	$	650		$	600
Short-term investments		110			100
Accounts receivable		2,750			2,500
Inventories		1,250			1,200
Total current assets	$	4,760		$	4,400
Net plant and equipment		3,850			3,500
Total assets	$	8,610		$	7,900
Liabilities and Equity
Accounts payable	$	1,300		$	1,200
Accruals		650			600
Notes payable		172			100
Total current liabilities	$	2,122		$	1,900
Long-term debt		1,300			1,200
Total liabilities	$	3,422			3,100
Common stock		3,874			4,000
Retained earnings		1,314			800
Total common equity	$	5,188		$	4,800
Total liabilities and equity	$	8,610		$	7,900

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

1. What is the net operating profit after taxes (NOPAT) for 2020? Enter your answer in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answer to the nearest whole number.

   $    million

2. What are the amounts of net operating working 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

3. 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

4. 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

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

     %

6. 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. Net Operating Profit after taxes for 2020:

Net Operating Profit after taxes = Total operating profit after tax excluding the tax savings benefits on interest

= Earnings before interest and taxes * (1-tax rate) = 1076 * (1-25%) = $ 807 million

b. Amounts of net operating working capital for 2019 and 2020

Net Operating Working Capital = Operating Current Assets - Operating current liabilities

Operating Current Assets = Total Current Assets - Short Term Investments

Operating Current Liabiliities = Total Current Liabilities - Notes payable

Net Operating Working Capital for 2020 = (4760-110) - (2122-172)=4650-1950=$2700 Million

Net Operating Working Capital for 2019 = (4400-100) - (1900-100)=4300-1800=$2500 Million

c. Amounts of total net operating capital for 2019 and 2020

Net Operating Capital = Net Operating Working Capital + Operating Long Term Assets

Operating Long Term Assets = Net Plant and Equipment

Net Operating Capital for 2020 = 2700+3850 = $6550 Million

Net Operating Capital for 2019 = 2500+3500 = $6000 Million

d. Free cash flow for 2020

Free Cash Flow = Earnings before Interest and Taxes (1-tax rate)+Depreciation-(Gross Investment in Fixed Assets + Investment in Net Operating Working Capital)

Gross Investment in Fixed Assets = Plant and Equipment of 2020-Plant and Equipment of 2019+Depreciation of 2020 = 3850-3500+400=750

Investment in Net Operating Working Capital = Net Operating Working Capital of 2020 - Net Operating Working Capital of 2019 = 2700-2500 = 200

= 1076*(1-25%)+400-(750+200) = 807+400-950=$257 Million

e. ROIC for 2020

Return on Invested Capital = Net Operating Profit after tax / Net Operating Capital

=807 / 6550=12.32%

f. How much of the FCF did Rhodes use for :

After tax interest payment for 2020 = Interest * (1-tax rate) = 120*(1-25%) = $90 Million

Reduction (increase) in debt = Debt in 2019 - Debt in 2020

Debt includes notes payable and long term debt

= (100+1200)-(172+1300)=1300-1472= -$172 Million

Payment of dividends = $203 Million (Given in the question in first table)

Repurchase (Issue) stock = Common Stock of 2019 - Common stock of 2020

= 4000-3874 = $126 Million

Purchase (Sale) of short term investments = short term investments of 2020 - short term investments of 2019

=110-100 = $10 Million

Thus, total free cash flow of 2020 = 90-172+203+126+10=$ 257 Million (same as (d) above).