Question

After graduating from college in December 2014, Elizabeth Arce started her career at the W&T Corporation, a small- to medium-sized warehouse distributor in Nashville, Tennessee. The company was founded by David Winston and Colin Tabor in 2000, after they had worked together in management at Wal-Mart. Although Arce had an offer from Sam's Club, she became excited about the opportunity with W&T. Winston and Tabor, as CEO and VP-marketing, respectively, assured her that she would be given every opportunity to take a leadership role in the business as quickly as she was prepared for the role. In addition to receiving a competitive salary, Arce will immediately be entitled to a bonus based on how well the company does financially. The bonus is determined by the amount of Economic Value Added (EVA) that is generated in a year. To begin, she will receive 1 percent of the firm's EVA each year, to be paid half in stock and half in cash. In any year that the EVA is negative, she will not receive a bonus. Also, the firm's stock is traded publicly on the NYSE MKT, a stock exchange for small-cap companies. The year of 2014 turned out to be a good year financially for the business. But in the ensuing year, 2015, the company experienced a 5.3 percent sales reduction, where sales declined from $5.7 million to $5.4 million. The downturn then led to other financial problems, including a 50 percent reduction in the company's stock price. The share price went from $36 per share at the end of 2014 to $18 per share at the conclusion of 2015! Financial information for W&T for both years is shown on the next page, where all the numbers, except for per share data, are shown in $ thousands. a. Using what you have learned in this chapter and Chapter 3, prepare a financial analysis of W&T, comparing the firm's financial performance between the 2? years. In addition to the financial information provided on the next page, the company's chief financial officer, Mike Stegemoller, has estimated the company's average cost of capital for all its financing to be 10.5 percent. b. What conclusions can you make from your analysis? c. How much will Arce's bonus be in 2014 and 2015, in the form of both cash and stock? How many shares of the stock will Arce receive? d. What recommendations would you make to management?

Answer 1

Let us first analyse P&L Account through vertical analysis and horizontal analysis

			Vertical Analysis		Horizontal Analysis
Particulars	2014	2015	2014	2015	2015
Sales	5,700	5,400	100.00%	100.00%	-5%
Cost of Goods Sold	3,700	3,600	64.91%	66.67%	-3%
Gross Profit	2,000	1,800	35.09%	33.33%	-10%
Operating Expenses
Selling & General Expenses	820	780	14.39%	14.44%	-5%
Depreciation	340	500	5.96%	9.26%	47%
Total Operating Expense	1,160	1,280	20.35%	23.70%	10%
Operating Profit	840	520	14.74%	9.63%	-38%
Interest Expenses	200	275	3.51%	5.09%	38%
Earning before taxes	640	245	11.23%	4.54%	-62%
Taxes	230	65	4.04%	1.20%	-72%
Net Income	410	180	7.19%	3.33%	-56%

Following are the main reason for bad performance of the company in 2015 :

a. There is decline in sales by 5% in 2015

b. The COGS is increased by 1.75% which is major hit to profitability. In number terms it reduced profit by 94.74K

c. The increase in depreciation needs inquiry. The amount invested in capital is 300K and corresponding rise in depreciation compared to 2014 is higher by 160K which is more than 50% of new investment. There could be couple of reason either the amount invested is subject to high depreciation rate or in 2014 there was significant investment which was added at last period hence the depreciation was not significant in last year

d. Another item is rising interest cost. It seems that to fund increased current asset and capital investment short term and long term funding have been utilised which is resulting into interest cost

Calculation of EVA :

EVA = Net Operating Profit After Taxes (NOPAT) - Invested Capital at beginning of period * Weighted Average Cost of Capital (WACC)

Invested Capital at beginning of period = Total Assets - Current liabilities - Current year Profit / Loss

Particualrs	2014	2015
Net operating profit after tax	410.00	180.00
Invested Capital at beginning of period(Total Assets - Current Liabilities)	3,615.00	3,980.00
WACC	0.11	0.11
EVA	30.43	(237.90)
1% of Firms Eva is eligibility for bonus	304.25	-
50% in Shares	152.13
Price per Share	18.00
Number of Shares	8.45

Recommendation :

The firm need to focus on improvement of sales as a first thing and also investigate the reason for increase in Cost of Sales. Sometime Cost of sales is out of control in such case a pricing decision needs to be considered provided it has no adverse effect on total volume of sales. Need to check the reason for incremental depreciation cost and adjust if required to reflect appropriate profitability.