IV. 2More4U In the Exhibit below, selected financial numbers from the latest fis

Question

IV. 2More4U
In the Exhibit below, selected financial numbers from the latest fiscal year (Year 10) as well as forecasts for the next 3 years for 2More4U Ltd. have been provided. As the figures indicate, 2More4U expect to grow substantially over the next 3 years. The CEO of 2More4U is uncertain if the high expected growth rates are in the firm’s best interest. Therefore, she asks you to explain to her:
1.Under which conditions growth is value creating 2. How growth generally affect a firm’s cash flows Further, based on the Exhibit she asks you to:
3. (5 points) Calculate 2More4U growth rate in sales for E1–E3 4. (5 points) Prepare a cash flow statement for E1–E3. Your cash flow statement should be divided into: Cash flows from operations Cash flows from investing Cash flows from financing
(try to provide in one table, where the first column lists all the items, while column 2 3 and 4 show the number for each of the year, respectively.) And to explain:
5. Whether cash flow from operations or operating earnings are better at explaining the performance (i.e. the value creation) of 2More4U in the Exhibit?
6. Why earnings are positive, while cash flows from operations are negative (in the forecast period)? In answering the questions, please make sure to state any assumptions that you make (if you are making any).

Income Statement (EURm) Year E1 E2 E3 Sales Cost of goods sold Gross profit SG&A; expenses Depreciation Earnings before interest and taxes Financial expenses, net Earmings before taxes Taxes Net earnings 400 600 200 (120) (100) (20) 800 (400) 400 (140)(180) (110)(120) 100 50 (43) 10 24 72 (33) 26 In 2010 sales (revenue) was 200.

Explanation / Answer

Cash flow is a very crucial statement which indicates the sources from which cash is coming into the business and the same are utilized. It is from three major areas-

1. Cash flow from operating activities. It is from normal trading activities of the concern. Profit will bring in cash and loss will cause outflow

2. Cash flow from investing activities: It is by purchase or sale of fixed assets and

3. Cash flow from financing activities.i.e. from purchase or sale of shares, new loan taken, repayment of loa etc.

a. In this problem, it is observed that net profit is growing as per projected income statement. It will add value to the business if it is higher than cost of capital of the concern. Cost of capital is the minimum required profit that company has to earn to satisfy its investors (stock holders, debt providers). If the shown growth rate is satisfying this requirement then some value addition will be made.

b. Growth in net profit generally affects increase in cash flow. Whatever profit is earned that should bring cash inflow. If it is not observed, then in real sense value addition is not made.

c. Consider the cash flow below. It clearly shows that cash inflows from trading activities are 45, 21 and 118. So it has decreased a little in second year. But in third year there is substantial increase in it. Thus in general there is growth in cash flow.

d. Statement of cash flow are shown below:

e. Cash flow from operations are better in explainin value creation. It indicates firm is performing better in trading activities and bringing net cash in the business.

f. Earning may be positive. But more than cash inflow from operating activities are used in finacing activities (repayment of loan, buy back of shares) and investing activities (purchase of asset)

Statement of cash flow for coming three years E1 E2 E3 A. Cash flow from operating activities: Net profit -33 26 63 Add Depreciation ( non cash flow item) 100 110 120 Add Interest (Finacing activity cash outflow) 23 26 28 Total 90 162 211 Add: Decrease in current asset    Inventory 15    Accounts receivable Less: Increase in current asset    Inventory 140 218    Accounts receivables 100 50 40 Add: Increase in current liabilities     Accouts payables 12 8 6     Bank notes payables 28 41 159 Cash flow from operating activities 45 21 118 B. Cash flow from Investing activities: Cash outflow from new purchase of assets 100 100 100 Cash outflow from Investing activities -100 -100 -100 C. Cash flow from Financing activities: Cash flow from equity stock 0 0 0 Payment of interest -23 -26 -28 Total cash flow from financing activities -23 -26 -28 1. Total cash flow -78 -105 -10 2. Opening cash balance 198 120 15 3.Closing cash flow [1+2] 120 15 5

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