Question

You're an industry analyst for the telecomm sector, and have been analyzing financial reports from two companies: CellT Corp. and Talk2Me Inc. The corporate tax rate for both firms is 35%. Your associate analyst has calculated and compiled, in the following table, a list of important figures you'll probably need for the analysis: Data Collected CellT Corp. EBIT $107,500 Depreciation $43,000 Total operating capital $632,100 Net investment in operating capital $301,000 WACC 8.84% Talk2Me Inc. $76,540 $30,616 $493,210 $159,100 11.50% In your analysis, you want to look for several characteristics one of them being the return on invested capital (ROIC). Using the information available, complete the following statements: • The net operating profit after tax (NOPAT) for CellT Corp. is , whereas the NOPAT for Talk2Me Inc. is . CellT Corp. has a free cash flow of , whereas, Talk2Me Inc. has a free cash flow of . CellT Corp. has a return on invested capital than Talk2Me Inc. has. Your inference from the analysis is that both firms are in a high-growth phase, and their growth will be profitable. Considering your analysis, which of the following statements is true? If ROIC is greater than the rate of return that investors require, which is the weighted average cost of capital (WACC), then the firm is adding value. If ROIC is less than the rate of return that investors require, which is the weighted average cost of capital (WACC), then the firm is adding value.

Answer 1

The net operating profit after tax (NOPAT) for CellT Corp is$69875, whereas for Talk2Me is $49751

Reason>

Net operating profit after tax (NOPAT) is a financial measure that shows how well a company performed through its core operations, net of taxes.

NOPAT is calculated as EBIT (earnings before interest and tax) x ( 1 – Tax Rate )

Celly Corp Talk2Me 2 EBIT 107500 76540 3 Depreciation 43000 30616 4 Total Operating Capital 632100 493210 5 Net investment in operating capital 301000 159100 6 WACC 8.84% 11.50% 7 8 Tax 9 NOPAT 35% 69875 49751 =B2*(1-18) =C2*(1-08) 10

CellT Corp has free cash flow -$231125, whereas for Talk2Me has free cash flow of -$109349

1 3 CellT Corp Talk2Me 2 EBIT 107500 76540 Depreciation 43000 30616 4 Total Operating Capital 632100 493210 5 Net investment in operating capital 301000 159100 6 WACC 8.84% 11.50% 12 Free Cash flow -231125 -109349 =B9-B5 =C9-C5 T 13

Reason>

Free cash flow (FCF) is the amount of cash available to investors after assets investments are made.

Free cash flow is calculated as NOPAT – Net Investment capital.

Note: As we are given Net Investment capital we are using the same. Incase we were given gross Investment capital the formula would have been

Free cash flow = ( NOPAT +Depreciation )– Gross Investment in operating capital

CellT Corp has higher return on invested capital than Talk2Me

Return on invested capital (ROIC), is a ratio used to as a measure the profitability and value-creating potential of companies relative to the amount of capital invested

ROIC = NOPAT / Total Operating Capital

CellT Corp Talk2Me 2 EBIT 107500 76540 3 Depreciation 43000 30616 4 Total Operating Capital 632100 493210 5 Net investment in operating capital 301000159100 6 WACC 8.84% 11.50% NOPAT 69875 49751 15 Return on invested capital (ROIC) 11.05% 10.09% -B9/34 29/04

Correct option.

If ROIC is greater than rate of return that investors require, which is weighted average cost of capital (WACC), then the firm is adding value

Reason:

WACC is type of average cost that is incurred for the capital that is employed in the firm. For a firm to add value the ROIC should ideally be greater that WACC, which implies that efficient use of the capital is being done and the firm is able to add value and earn more returns than its cost of capital.