Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his position as manager of cost systems for Davis, Cohen, and O?Brien Public Accountants and started Track Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and O?Brien, Stanley had spent nights and weekends developing a sophisticated cost-accounting software program that became Track?s initial product offering. As the firm grew, Stanley planned to develop and expand the software product offerings, all of which would be related to streamlining the accounting processes of medium- to large-sized manufacturers. Although Track experienced losses during its first 2 years of operation?2009 and 2010?its profit has increased steadily from 2011 to the present (2015). The firm?s profit history, including dividend payments and contributions to retained earnings, is summarized in Table 1.
Stanley started the firm with a $100,000 investment: his savings of $50,000 as equity and a $50,000 long-term loan from the bank. He had hoped to maintain his initial 100 percent ownership in the corporation, but after experiencing a $50,000 loss during the first year of operation (2009), he sold 60 percent of the stock to a group of investors to obtain needed funds. Since then, no other stock transactions have taken place. Although he owns only 40 percent of the firm, Stanley actively manages all aspects of its activities; the other stockholders are not active in management of the firm. The firm?s stock was valued at $4.50 per share in 2014 and at $5.28 per share in 2015.
TABLE 1
Track Softare, Inc.
Profit, Dividends, and Retained Earnings, 2009-20015
Year Net profits aftet taxes (1) Dividends Paid (2) Contributions to retained earnigns [(1)-(2)] (3)
2009 ($50,000) $0 ($50,000)
2010 (20,000) $0 ($20,000)
2011 15,000 $0 15,000
2012 35,000 $0 35,000
2013 40,000 $1000 39,000
2014 43,000 $3000 40,000
2015 48,000 $5000 $43,000
Stanley has just prepared the firm?s 2015 income statement, balance sheet, and statement of retained earnings, shown in Tables 2, 3, and 4, along with the 2014 balance sheet. In addition, he has compiled the 2014 ratio values and industry average ratio values for 2015, which are applicable to both 2014 and 2015 and are summarized in Table 5. He is quite pleased to have achieved record earnings of $48,000 in 2015, but he is concerned about the firm?s cash flows. Specifically, he is finding it more and more difficult to pay the firm?s bills in a timely manner and generate cash flows to investors, both creditors and owners. To gain insight into these cash flow problems, Stanley is planning to determine the firm?s 2015 operating cash flow (OCF) and free cash flow (FCF). Stanley is further frustrated by the firm?s inability to afford to hire a software developer to complete development of a cost estimation package that is believed to have ?blockbuster? sales potential. Stanley began development of this package 2 years ago, but the firm?s growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product.
Stanley?s reluctance to fill this position stems from his concern that the added $80,000 per year in salary and benefits for the position would certainly lower the firm?s earnings per share (EPS) over the next couple of years. Although the project?s success is in no way guaranteed, Stanley believes that if the money were spent to hire the software developer, the firm?s sales and earnings would significantly rise once the 2- to 3-year development, production, and marketing process was completed. With all these concerns in mind, Stanley set out to review the various data to develop strategies that would help ensure a bright future for Track Software. Stanley believed that as part of this process, a thorough ratio analysis of the firm?s 2015 results would provide important additional insights.
TABLE 2
Track Software, Inc., Income Statement ($000)
for the Year Ended December 31, 2015
Sales revenue $ 1,550
Less: Cost of goods sold $ 1,030
Gross profits $ 520
Less: Operating expenses
Selling expense $ 150
General and administrative expenses 270
Depreciation expense 11
Total operating expense 431
Operating profits (EBIT) $ 89
Less: Interest expense 29
Net profits before taxes $ 60
Less: Taxes (20%) 12
Net profits after taxes $ 48
TABLE 3
Track Software, Inc., Balance Sheet ($000)
December 31
Assets 2015 2014
Cash $ 12 $ 31
Marketable securities 66 82
Accounts receivable 152 104
Inventories 191 145
Total current assets $421 $362
Gross fixed assets $195 $180
Less: Accumulated depreciation 63 52
Net fixed assets $132 $128
Total assets $553 $490
Liabilities and stockholders? equity
Accounts payable $136 $126
Notes payable 200 190
Accruals 27 25
Total current liabilities $363 $341
Long-term debt $ 38 $ 40
Total liabilities $401 $381
Common stock (50,000 shares outstanding
at $0.40 par value) $ 20 $ 20
Paid-in capital in excess of par 30 30
Retained earnings 102 59
Total stockholders? equity $152 $109
Total liabilities and stockholders? equity $553 $490
TABLE 4
Track Software, Inc.,
Statement of Retained Earnings ($000)
for the Year Ended December 31, 2015
Retained earnings balance (January 1, 2015) $ 59
Plus: Net profits after taxes (for 2015) 48
Less: Cash dividends on common stock (paid during 2015) 5
Retained earnings balance (December 31, 2015) $102
TABLE 5
Ratio Actual Industry Average
2014 2015
Current ratio 1.06 1.82
Quick ratio 0.63 1.10
Inventory turnover 10.40 12.45
Average collection period 29.6 days 20.2 days
Total asset turnover 2.66 3.92
Debt ratio 0.78 0.55
Times interest earned ratio 3.0 5.6
Gross profit margin 32.1% 42.3%
Operating profit margin 5.5% 12.4%
Net profit margin 3.0% 4.0%
Return on total assets (ROA) 8.0% 15.6%
Return on common equity (ROE) 36.4% 34.7%
Price/earnings (P/E) ratio 5.2 7.1
Market/book (M/B) ratio 2.1 2.2
Read the Track Software case (Integrative Case 2) in your textbook and answer questions a-g at the end of the case. The case is cumulative and incorporates concepts learned throughout the course. Keep the following in mind as your complete the assignment:
- Unless otherwise noted by your instructor, each question is worth 10 points.
- In question b, calculate EPS for each year 2009-2015.
- In question d, make sure to include each ratio listed in Table 5 of the case for both 2014 and 2015. You will have to calculate the 2015 ratio values.
- For question d, you are required to write an evaluation of each area of performance as part of your answer. Merely citing numerical ratio values will not earn full credit.
- Note that your answers for questions f and g do not necessarily match.
Answer all questions on an Excel spreadsheet using the same guidelines for spreadsheet development used for your homework assignments. See “Guidelines for Developing Spreadsheets” for a full description of additional requirements.
- Submit a single spreadsheet file for this assignment, do not submit multiple files.
- Answer each question on a different spreadsheet tab.
- Label all numbers, both variables and the final answer.
- Use the yellow highlighter on Excel’s top menu bar to highlight your final answer.