SYNDICATE 10

Elizabeth Elvienna - 29118060

Gema Rendrahadi - 29118194
I Made Devantara – 29118149

Track Software, Inc

a. (1) On what financial goal does Stanley seem to be focusing? Is it the correct goal?
Why or why not?
Stanley focuses on maximizing the firm sales and earnings. This is the correct goal because
profit maximization is the main concern for most company in order to sustain their business.
Although in order to achieve this goals, Stanley wants to hire a Software Developer to complete
development of a cost estimation package that is believed to have “blockbuster” sales potential.
But it said that the project’s success is in no way guaranteed but Stanley as a manager believes that
if the money were spent to hire the software developer, the firm’s sales and earnings would
significantly rise once the 2-3 years development, production, and marketing process was
completed. So, in order to maximize the firm sales and earnings, the company must to bear some
risk in investing on a software developer to help increase its sales potential significantly.

(2) Could a potential agency problem exist in this firm? Explain.

Yes. Agency problem may occur when manager place personal goals ahead of the goals of
shareholders. In this case, although Stanley only owns 40% of the firm, he actively manages all
aspects of its activities because the other stockholders are not active in management of the firm.
Moreover, Stanley decide wants to invest in the software developer. The investment may give rise
to agency cost because the investment may cause a temporary decrease in the firm’s EPS which
will also decrease the firm’s earning that will be distributed to the shareholders. This will be a
problem if the goal of shareholder is to gain profit faster than later because the cost of investment
will be borne by the shareholders.
 b. Calculate the firms EPS each year
!"#$%$&' ")"%*"+*, -.# /.00.$ '1./23.*4,#'
EPS =
560+,# .- '3"#,' .- /.00.$ '1./2 .61'1"$4%$&

Year EPS
2009 7
= = $0
87.777

2010 7
= = $0
87.777

2011 :8.777
= = $0.30
87.777

2012 ;8.777
= = $0.70
87.777

2013 <7.777
= = $0.80
87.777

2014 <;.777
= = $0.86
87.777

2015 <=.777
= = $0.96
87.777

From the data above, EPS from 2009 – 2015 shows a steady increase. Although the EPS for
2009 and 2010 is $0, this happens because Track’s still experiencing negative Net Profit After
Tax. An increasing EPS over years, indicates that the company’s earning power is increasing.
Growth in EPS is an important measure of management performance because it shows how much
money the company is making for its shareholders. The higher the EPS means the more money
your shares of stock will be worth because investors are willing to pay more for having higher
profits.

c. Operating Cash Flow (OCF)

OCF = [EBIT x (1-T)] + Depreciation
OCF 2015 = [89.000 X (1-20%)] + 11.000
= $82.200
During 2015, Track’s generated $82.200 of cash flow from production and selling its
software. Therefore, we can conclude that Track’s operations are generating positive cash flow.
 Free Cash Flow (FCF)
FCF = OCF – Net fixed asset investment (NFAI) – Net current asset investment (NCAI)
OCF = 82.200

NFAI = Change in net fixed asset + depreciation

= (132.000-128.000) +11.000
= 15.000
NCAI = Change in current asset – Change in (account payable + accruals)
= [(421.000 - 362.000) – [(136.000 +27.000) – (126.000+25.000)]]
= 59.000 – 12.000
= 47.000
FCF 2015 = 82.200 – 15.000 – 47.000
= 20.200

From the calculations above, we can see that during 2015 Track’s generated $20.200 of free
cash flow, which it can use to pay its investors (owners and creditors). Thus, the firm generated
adequate cash flow to cover all its operation costs and investments.

d. Analyze the firm’s financial condition in 2015 (both cross sectional and time series
basis):
(1) Liquidity Ratios
Ratio Actual 2014 Actual 2015 Industry
Average 2015
/6##,$1 "'',1 1.06 <>:.777 1.82
Current Ratio = = 1.16
/6##,$1 *%"+%*%1%,' ;?;.777
/6##,$1 "'',1@%$),$1.#A 0.63 <>:.777@:B:.777 1.10
Quick Ratio = = 0.63
/6##,$1 *%"+%*%1%,' ;?;.777

Current ratio shows the ability of Track’s to meet its short term obligations using liquid
assets. Compared to 2014, the current ratio in 2015 is increasing 9.4%. This indicates the ability
of Track’s is getting better at paying off short-term liabilities.
 Quick ratio is used to measure a company's ability to repay short-term liabilities by using
more liquid assets (without including inventory in the calculation of current assets). In this
case, the quick ratio stays the same from 2014 to 2015.
The quick and current ratio of the industry average is both higher compared to Track’s.
This means that Track’s need to catch up by increasing sales in order to increase cash that can
be used to meet its short term obligation and perform at least the same with the industry
average. The overall liquidity of the firm seems to be stable.

(2) Activity Ratios

Ratio Actual Actual 2015 Industry
2014 Average
2015
C.'1 .- &..4' '.*4 10.40 :.7;7.777 12.45
Inventory Turnover = = 5.39
%$),$1.#A :B:.777

Average Collection Period 29.6 days :8>.777 20.2 days

= 35.8 days
:.887.777/;?8
D//.6$1 #,/,%)"+*,
=
D),#"&, E"*,' F,# G"A
E"*,' 2.66 :.887.777 3.92
Total Asset Turnover = = 2.80
I.1"* D'',1' 88;.777

In 2015, the inventory turnover decreased by 48.2% compared with 2014 which indicates
a slow inventory movement. This happen because there may be a decrease in Cost of Goods
Sold in 2015 compared to 2014. Moreover, compared to the inventory turnover of industry
average in 2015 which is 12.45, Track’s inventory turnover is considered very low.
Average collection period in 2015 increase becoming 35.8 days from 29.6 days. This
indicates that Track’s needs longer time in order to collect its account receivable. Meanwhile,
the industry average is 20.2 days. This means the company needs to improve its average time
in collecting its receivable by considering an early payment discount or be proactive in
collection efforts.
The total asset turnover ratio measures the company’s overall ability to generate revenues
with a given level of assets. In 2015, there is a 5.2% increase of the total asset turnover ratio
compared to 2014. The total asset turnover ratio in 2015 is increasing to the amount of 2.80
which indicate that Track’s is generating Rp2.80 of revenues for every Rp1 of average assets.
 This may happens because there is an increase of revenue or decline of assets. This indicates
that Track’s improves its efficiency through better performance. Meanwhile the average
industry is 3.92, this means in order to be at least the same with other competitors, Track’s still
need to perform better.

(3) Debt Ratios

Ratio Actual 2014 Actual 2015 Industry

Average 2015
I.1"* *%"+%*%1%,' 0.78 <7:.777 0.55
Debt Ratio = = 0.725
I.1"* "'',1' 88;.777
!JKI 3.0 =B.777 5.6
Time interest earned ratio = = 3.07
K$1,#,'1 >B.777

Total debt indicates the contribution of debt to acquire assets. In 2015, its debt ratio
decrease by 7.6%. The lower the ratio of total debt illustrates that company’s performance
improvement. But the industry average debt ratio is lower which is 0.55. Track’s need to improve
its debt ratio by issuing new stock or debt/equity swap.
Time interest earned ratio measure the firm ability to make contractual interest payments.
Track’s ratio increase 2.3% in 2015 from 3.0 to 3.07. This indicates that Track’s is better in
fulfilling its interest obligations. Comparing with the industry average, which is 5.06, Track’s ratio
is still way lower but still acceptable. (a value at least 3.00 and preferably closer to 5.00 is often
suggested). Track’s indebtedness decrease and is currently above the industry average. Although
this increase could be an alarm, the firm’s ability to meet interest obligations improved even though
it still not outperforms the industry. The company’s improved ability to pay debt compensates for
its degree of indebtedness.

(4) Profitability Ratios

Ratio Actual 2014 Actual 2015 Industry
Average 2015
L#.'' F#.-%1 32.1% 8>7.777 42.3%
Gross Profit Margin = = 33.55%
E"*,' :.887.777
 Operating Profit Margin 5.5% =B.777 12.4%
= 5.74%
:.887.777
MF,#"1%$& F#.-%1
=
E"*,'
<=.777
Net Profit Margin = 3.0% = 3.10% 4%
:.887.777
!"#$%$&' ")"%*"+*, -.# /.00.$ '1./23.*4,#
E"*,'

Return On Total Assets (ROA) 8.0% <=.777 15.6%

= 8.68%
88;.777
!"#$%$&' ")"%*"+*, -.# /.00.$ '1./23.*4,#
=
I.1"* D'',1'

Return On Common Equity (ROE) 36.4% <=.777 34.7%

= 31.58%
:8>.777
!"#$%$&' ")"%*"+*, -.# /.00.$ '1./23.*4,#
=
C.00.$ E1./2 !O6%1A

Gross profit margin shows the company's ability to produce a gross profit of each sale that
indicate the company's ability to make efficiency and effectiveness in its production. An increase
in gross profit margin in 2015 amounted to 4.5% compared to the year 2014 where the greater
gross profit margin means the better the state of the company's operations.
Operating profit margin measures the percentage of each sales dollar remaining after all costs
and expenses other than interest, taxes and preferred stock are deducted. In 2015, operating margin
is slightly increase for 4.4%.
Net profit margin is a ratio used to indicate the company's ability to generate net benefits. This
ratio also indicates how much percentage of the net profit earned from each sale. Net profit margin
in 2015 increased by 3.33% compared to the year 2014, where the greater the Net Profit Margin
indicates that the company considered more productive so it may enhance the confidence of
investors to invest in the company.
ROA measures the return earned by a company on its assets. In 2015, ROA is slightly
increasing from 8% to 8.68% which indicates higher profitability.
ROE measures the return earned on the common stockholder’s investment in the firm.
Overall from 2014 to 2015, the trend in ROE is declining substantially that may resulted from
decreases in operating profit. A company can improve ROE by improving ROA or making more
effective use of leverage (average total assets divided by average shareholder’s equity).
Although the gross profit margin, operating profit margin, net profit margin and ROA are
increasing, all the profitability ratios are still below the industry average in 2015. In order to
increase overall Track’s profitability, it needs to reduce cost, increase turnover, and increase
productivity and also efficiency.

(5) Market Ratios

Ratio Actual Actual 2015 Industry
2014 Average
2015
Price/Earnings (P/E) Ratio 5.2 8.>= 7.1
= 5.50
7.B?
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟
=
𝐸𝑃𝑆
Market/Book (M/B) Ratio 2.1 8.>= 2.2
ghi = 1.74
hj
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘

Investors have greater confidence in the firm in 2015 than the previous year as reflected in the
increase of P/E ratio to 5.50. However, this ratio is still below the average industry ratio. The P/E
ratio suggests that the firm’s risk has declined but remains above the average firm in the industry.
Meanwhile the M/B ratio decreased in 2015 and perform below the average industry which
indicates that investors is less optimist about the firm’s future performance.

In summary, the firms appear to be growing reflected by the increasing of its performance in
2015 compared to 2014. But Track’s has to keep improving its performance in order to be at
least the same with the average firm in the industry.

e. What recommendation would you make to Stanley regarding hiring a new software
developer? Relate your recommendation here to your responses in part a.
Stanley should try to hire the software developer by convincing the shareholders that the
investment on the software developer will give the desired return (significant increase in sales and
earnings) although the added $80.000 per year in salary and benefits may lower the EPS over the
next couple of years. This decision may be supported by the fact that in 2015 the firm has generated
adequate cash flow to cover all its operation costs and investments so it’s still possible to afford
the Software Developer.
 f. Track Software paid $5.000 in dividends in 2015. Suppose that an investor
approached Stanley about buying 100% of his firm. If this investor believed that by
owning the company he could extract $5.000 per year in cash from the company in
perpetuity, what do you think the investor would be willing to pay for the firm if the
required return on this investment is 10%?
𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 $5000
𝑊𝑖𝑙𝑙𝑖𝑛𝑔𝑛𝑒𝑠𝑠 𝑡𝑜 𝑝𝑎𝑦 = = = $50,000
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 0.1

The investor would be willing to pay $50,000 for the firm in order to received 10% required
return on the investment.

g. Suppose that you believed that the FCF generated by Track Software in 2015 could
continue forever. You are willing to buy the company in order to receive this
perpetual stream of free cash flow. What are you willing to pay if you require a 10%
return on your investment?
𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 $20.200
𝑊𝑖𝑙𝑙𝑖𝑛𝑔𝑛𝑒𝑠𝑠 𝑡𝑜 𝑝𝑎𝑦 = = = $202,000
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 0.1

In order to received 10% return on the investment, the willingness to pay in buying the
company is $202.000.