Track Software paid $5,000 in dividends in 2015. Suppose that an

| June 6, 2016

Question
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%?

Seven years ago, after 15 years in public accounting, Stanley Booker, CPA,
resigned his position as manager of cost systems for Davis, Cohen, and
OBrien Public Accountants and started Track Software, Inc. In the 2 years
preceding his departure from Davis, Cohen, and OBrien, Stanley had spent
nights and weekends developing a sophisticated cost-accounting software
program that became Tracks 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 mediumto large-sized manufacturers. Although Track experienced losses during its
first 2 years of operation2009 and 2010its profit has increased steadily
from 2011 to the present (2015). The firms 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 firms 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, 2009­20015
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 firms 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
firms cash flows. Specifically, he is finding it more and more difficult to pay

the firms 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 firms 2015 operating cash flow (OCF) and free
cash flow (FCF). Stanley is further frustrated by the firms 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 firms growing
complexity has forced him to devote more of his time to administrative duties,
thereby halting the development of this product.
Stanleys 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 firms earnings per share (EPS) over the next couple of years.
Although the projects success is in no way guaranteed, Stanley believes
that if the money were spent to hire the software developer, the firms 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 firms 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 a­g 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 2009­2015.

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 Excels top menu bar to highlight your final answer.

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