Chapter 15, Problem 4MAD

a.

To determine

Identify the company which appears to be the largest at the end of Year 3, based on revenue.

Answer to Problem 4MAD

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

Explanation of Solution

Statement of cash flows:

Statement of cash flow is a financial statement that shows the cash and cash equivalents of a company for a particular period of time. It shows the net changes in cash, by reporting the sources and uses of cash as a result of operating, investing, and financing activities of a company.

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 revenue earning company at the end of Year 3.

b.

To determine

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

Answer to Problem 4MAD

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

Explanation of Solution

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

Company	Year 3	Year 2	Year 1
AT	124% (1)	111% (2)	100%
F	222% (3)	144% (4)	100%

Table (1)

Working note (1):

Calculate the growth rate of Company AT for Year 3.

$\begin{array}{c}\text{Growth rate for Year 3=}\left(\frac{\text{Revenue for Year 3}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$163,786}{\$132,447}\times 100\\ =124\%\end{array}$

Working note (2):

Calculate the growth rate of Company AT for Year 2.

$\begin{array}{c}\text{Growth rate for Year 2=}\left(\frac{\text{Revenue for Year 2}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$146,801}{\$132,447}\times 100\\ =111\%\end{array}$

Working note (3):

Calculate the growth rate of Company F for Year 3.

$\begin{array}{c}\text{Growth rate for Year 3=}\left(\frac{\text{Revenue for Year 3}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$27,638}{\$12,466}\times 100\\ =222\%\end{array}$

Working note (4):

Calculate the growth rate of Company F for Year 2.

$\begin{array}{c}\text{Growth rate for Year 2=}\left(\frac{\text{Revenue for Year 2}}{\text{Revenue for Year 1}}\right)\\ \text{=}\frac{\$17,928}{\$12,466}\times 100\\ =144\%\end{array}$

Conclusion

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

c.

To determine

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 AT	Year 3	Year 2	Year 1
Cash flows from operating activities (A)	$39,344	$35,880	$31,338
Cash used to purchase property, plant, and equipment (B)	$22,408	$20,015	$21,433
Cash used to purchase property, plant, and equipment as a percentage  of the cash flows from operating activities $\left(\text{C}\right)=\left(\text{B}\right)÷\left(\text{A}\right)$	57%	56%	68%

Company F	Year 3	Year 2	Year 1
Cash flows from operating activities (A)	$16,108	$10,320	$7,326
Cash used to purchase property, plant, and equipment (B)	$4,491	$2,523	$1,831
Cash used to purchase property, plant, and equipment as a percentage  of the cash flows from operating activities $\left(\text{C}\right)=\left(\text{B}\right)÷\left(\text{A}\right)$	28%	24%	25%

Table (2)

d.

To determine

Identify the company which appears to require more cash to purchase property, plant, and equipment and explain its impact on free cash flow, based on findings of part (c).

Answer to Problem 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 AT, 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 AT of 68%. Both the company’s requirement of cash is increasing year by year, but Company AT’s requirement is higher than Company F’s requirement.

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

e.

To determine

Compute the ratio of free cash flow to revenue for all three years for each company, and plot the data on a line chart.

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
Less: 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 revenue $\text{C=}\left(\frac{\text{A}}{\text{B}}\right)$	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
Less: 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 revenue $\text{C=}\left(\frac{\text{A}}{\text{B}}\right)$	42.0%	43.5%	44.1%

Table (6)

Plot the free cash flow to revenue of both the companies on a line chart.

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 is 42.0%, 43.5%, and 44.1% respectively.

f.

To determine

Interpret the chart.

Explanation of Solution

The ratio of free cash flow to revenue of Company F for Year 1 was better when compared to Company AT, as Company F’s ratio is almost 6 times higher than Company AT’s ratio. But in the Year 2, and Year 3, the ratios of free cash flow to revenue of Company F were not much greater than Company AT.

Individually, both companies ratio is remained stable over the years, as both the cash flow from operating activities and cash used to purchase property, plant, and equipment were increasing steadily. However, Company F’s requirement to purchase property, plant, and equipment has increased more than the increase in cash flow from operating activities.

This has caused the decline in the ratio of free cash flow to revenue for Company F in year 2 and year 3.