Chapter 13, Problem 13.4MAD

a.

To determine

To Identify: The company which appears to be the largest at the end of Year 3.

Answer to Problem 13.4MAD

The company which appears to be the largest using the revenue at the end of Year 3 is Company AT.

Explanation of Solution

Company AT has more revenue of $163,786 which is more than the revenue of Company F of revenue $27,638. Hence, Company AT appears to be the largest using the revenue at the end of Year 3.

b.

To determine

To Identify: The company which appears to be growing faster across the three years.

Explanation of Solution

Identify the company which appears to be growing faster across the three years.

Company	Year 3	Year 2	Year 1
AT	123% (1)	110% (2)	100%
F	221% (3)	143% (4)	100%

Table (1)

Working Note:

Calculate the growth rate of Company AT for the two years.

$\begin{array}{c}\text{Growth rate for Year 3=}\left(\frac{\text{Revenue for Year 3}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$163,786}{\$132,447}\times 100\\ =123\%\\ \end{array}$ (1)

$\begin{array}{c}\text{Growth rate for Year 2=}\left(\frac{\text{Revenue for Year 2}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$146,801}{\$132,447}\times 100\\ =110\%\\ \end{array}$ (2)

Calculate the growth rate of Company F for the two years.

$\begin{array}{c}\text{Growth rate for Year 3=}\left(\frac{\text{Revenue for Year 3}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$27,638}{\$12,466}\times 100\\ =221\%\\ \end{array}$ (3)

$\begin{array}{c}\text{Growth rate for Year 2=}\left(\frac{\text{Revenue for Year 2}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$17,928}{\$12,466}\times 100\\ =143\%\\ \end{array}$ (4)

Conclusion

Hence, the company which appears to be growing faster across the three years is Company F.

c.

To determine

To Compute: The cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities for all three years for each company.

Explanation of Solution

Compute the cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities for all three years for each company.

Company	Year 3	Year 2	Year 1
AT	56% (5)	56% (6)	68% (7)
F	28% (8)	24% (9)	25% (10)

Table (2)

Working Note:

Calculate the cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities of Company AT for three years.

For Year 3:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash used to purchase property, plant}\\ \text{and equipment as a percent of cash flows }\end{array}\right)\text{=}\left(\frac{\begin{array}{l}\text{Cash used to purchase}\\ \text{property, plant, and}\\ \text{equipment}\end{array}}{\begin{array}{l}\text{Cash flows from}\\ \text{operating activities}\end{array}}\right)\\ \text{=}\frac{\$22,408}{\$39,344}\times 100\\ =56\%\\ \end{array}$ (5)

For Year 2:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash used to purchase property, plant}\\ \text{and equipment as a percent of cash flows }\end{array}\right)\text{=}\left(\frac{\begin{array}{l}\text{Cash used to purchase}\\ \text{property, plant, and}\\ \text{equipment}\end{array}}{\begin{array}{l}\text{Cash flows from}\\ \text{operating activities}\end{array}}\right)\\ \text{=}\frac{\$20,015}{\$35,880}\times 100\\ =56\%\end{array}$ (6)

For Year 1:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash used to purchase property, plant}\\ \text{and equipment as a percent of cash flows }\end{array}\right)\text{=}\left(\frac{\begin{array}{l}\text{Cash used to purchase}\\ \text{property, plant, and}\\ \text{equipment}\end{array}}{\begin{array}{l}\text{Cash flows from}\\ \text{operating activities}\end{array}}\right)\\ \text{=}\frac{\$21,433}{\$31,338}\times 100\\ =68\%\end{array}$ (7)

Calculate the cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities of Company F for three years.

For Year 3:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash used to purchase property, plant}\\ \text{and equipment as a percent of cash flows }\end{array}\right)\text{=}\left(\frac{\begin{array}{l}\text{Cash used to purchase}\\ \text{property, plant, and}\\ \text{equipment}\end{array}}{\begin{array}{l}\text{Cash flows from}\\ \text{operating activities}\end{array}}\right)\\ \text{=}\frac{\$4,491}{\$16,108}\times 100\\ =28\%\end{array}$ (8)

For Year 2:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash used to purchase property, plant}\\ \text{and equipment as a percent of cash flows }\end{array}\right)\text{=}\left(\frac{\begin{array}{l}\text{Cash used to purchase}\\ \text{property, plant, and}\\ \text{equipment}\end{array}}{\begin{array}{l}\text{Cash flows from}\\ \text{operating activities}\end{array}}\right)\\ \text{=}\frac{\$2,523}{\$10,320}\times 100\\ =24\%\end{array}$ (9)

For Year 1:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash used to purchase property, plant}\\ \text{and equipment as a percent of cash flows }\end{array}\right)\text{=}\left(\frac{\begin{array}{l}\text{Cash used to purchase}\\ \text{property, plant, and}\\ \text{equipment}\end{array}}{\begin{array}{l}\text{Cash flows from}\\ \text{operating activities}\end{array}}\right)\\ \text{=}\frac{\$1,831}{\$7,326}\times 100\\ =25\%\end{array}$ (10)

d.

To determine

To Identify: The company which appears to require more cash to purchase property, plant, and equipment and to explain its impact on free cash flow.

Answer to Problem 13.4MAD

By using the computation in (C), it is clear that the company which appears to require more cash to purchase property, plant, and equipment is Company F, and its impact on free cash flow is more negative.

Explanation of Solution

The cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities of Company F for Year 1 is 25% which is much less than that of Company F of 68%. But for Year 2, and Year 3, the cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities of Company AT are 56%, and 56%, which are greater than those of Company F of 24%, and 28%.

Hence, as the cash used to purchase property, plant, and equipment as a percent of the cash flows from operating activities of Company F from Year 1 to Year 3 is increasing, the company which appears to require more cash to purchase property, plant, and equipment is Company F and its net impact on free cash flow is more negative.

e.

To determine

To Compute: The ratio of free cash flow to revenue for all three years for each company.

Explanation of Solution

Compute the free cash flow of Company AT.

	Year 3	Year 2	Year 1
Cash flows from operating activities	$ 39,344	$35,880	$ 31,338
Cash used to purchase property, plant, and equipment	(22,408)	(20,015)	(21,433)
Free cash flow	$ 16,936	$15,865	$ 9,905

Table (3)

Compute the ratio of free cash flow to revenue for Company AT.

	Year 3	Year 2	Year 1
Free cash flow  (A)	$ 16,936	$15,865	$ 9,905
Revenue     (B)	163,786	146,801	132,447
Ratio of free cash flow to revenues $\text{C=}\left(\frac{\text{A}}{\text{B}}\right)$	10.3%	10.8%	7.5%

Table (4)

Compute the free cash flow of Company F.

	Year 3	Year 2	Year 1
Cash flows from operating activities	$16,108	$10,320	$7,326
Cash used to purchase property, plant, and equipment	(4,491)	(2,523)	(1,831)
Free cash flow	$ 11,617	$7,797	$ 5,495

Table (5)

Compute the ratio of free cash flow to revenue for Company F.

	Year 3	Year 2	Year 1
Free cash flow  (A)	$ 11,617	$7,797	$ 5,495
Revenue     (B)	27,638	17,928	12,466
Ratio of free cash flow to revenues $\text{C=}\left(\frac{\text{A}}{\text{B}}\right)$	42%	43.4%	44%

Table (6)

Conclusion

Hence, the ratio of free cash flow to revenue for Year 3, Year 2, and Year 1 for Company AT are 10.3%, 10.8%, and 7.5% respectively. And for Company F, they are 42%, 43.4%, and 44% respectively.

F.

To determine

To plot: The data on a line chart with the years on the horizontal axis.

Explanation of Solution

Plot the data on a line chart with the years on the horizontal axis.

Figure (1)

The ratio of free cash flow to revenue of Company AT for Year 1 was better when compared to Company F. But in the Year 2, and Year 3, the ratios of free cash flow to revenue of Company F were much greater than Company AT. The cash flows from operating activities of Company F have significantly increased over the years. Due to this, there is an increase in the ratio of free cash flows to revenues. The decline in the ratio of free cash flows to revenues of Company AT is due to the decline in the cash flows from operating activities, and increase in the cash needed to purchase property, plant, and equipment over the three years. The net result of this is that the ratio is declined.