case 3 problemCASE NO. 3 TRACK SOFTWARE, INC.Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his posiitionas Manager of Cost Systems for Davis, Cohen, and O'Brien Public Accountants and startedTrack Software, Inc., In the 2 years preceding his departure from Davis, Cohen ans O'Brien,Stanley has spent nights and weekends developing a sophisticated cost-accounting softwareprogram that became Track's initial product offering . As the firm grew, Stanley planned to developand expand the product offerings - all of which would be related to streamlining the processes ofmedium-to-large sized manuufacturers.Although Track experienced losses during its first two years of operation - 2000 to 2001 - itsprofit has increased steadily from 2002 to the present (2006). The firm's profit history, includingdividend payment contributions to retained earnings is summarized in Table 1.Stanley started the firm with $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 ownershipin the corporation, but after experiencing a $50,000 loss during the first year of operation (2000)he sold 60 percent of the stock to a group of investors to obtain needed funds. Since then, noother stock transactions have taken place. Although he owns only 40 percent of the firm, Stanleyactively manages all aspects of its activities; the other stockholders are not active in managementof the firm. The firm's stock was valued at $4.50 per share in 2005 and at $5.28 per share in 2006.TABLE 1ContributionNet ProfitsDividendsto Retainedafter TaxesPaidEarningsYear(1)(2)(3)2000$(50,000)$0.0$(50,000)2001(20,000)0.0(20,000)200215,0000.015,000200335,0000.035,000200440,0001,00039,000200543,0003,00040,000200648,0005,00043,000Stanley has just prepared the firm\s 2006 income statement, balance sheet and statement of retainedearnings, shown in Tables 2 , 3 and 4, along with the 2005 balance sheet, In addition, he has compliedthe 2005 ratio values and industry average ratio values for 2006, which are applicable to both 2005 and2006 and are summarized in Table 5. He is quite pleased to have achieved record earnings of $48,000in 2006, but he is concerned about the firm's cash flows. Specifically, he is finding it more and moredifficult to pay the firm's bills in a timely manner and generate cash flows to investors - both creditorsand owners. To gain insight into these cash flow problems, Stanley is planning to determine the firm's2006 operating cash flow (OCF) and free cash flow (FCF).Stanley is further frustrated by the the firms' inability to afford to hire a software developer to completedevelopment of a cost estimation package that is believed to have "blockbuster" sales potential.Stanley began development of this package 2 years ago, but the firm's growing complexity has forcedhim to devote more of his time to administrative duties, thereby halting the development of this product.Stanley's reluctance to fill this position stems from his concern that the added $80,000 per year insalary and benefits for the position would certainly lower the firm's earnings per share (EPS) over thenext couple of years. Although the project's success is in no way guaranteed , Stanley believes thatif the money were spent to hire the software developer, the firm's sales and earnings would significantlyrise once the 2 to 3- year development, production, and marketing process was completed.Table 2Track Software, Inc.Income Statement ($000)For the Year Ended December 31, 2006Sales revenue$1,550Less: Cost of goods sold1,030Gross profits520Less: Operating expensesSelling expenses$150General and administrative expenses270Depreciation expense11Total operating expense431Operating profits (EBIT)89Less: Interest expense29Net profits before taxes60Less: Taxes (20%)12Net profits after taxes48Table 3Track Software, Inc.Balance Sheet ($000)As at December 31, 200631-DecAssets20062005Current AssetsCash$12$31Marketable securities6682Accounts receivable152104Inventories191145Total Current Assets421362Gross Fixed Assets195180Less Accumulated depreciation6352Net fixed assets132128Total assets553490Liabilities and Stockholders' EquityCurrent LiabilitiesAccounts payable136126Notes payable200190Accruals2725Total Current Liabilities363341Long term debt3840Total liabilities401381Stockholders' EquityCommon stock (50,000 shares outstanding@$.40 par value2020Paid-in-capital in excess of par3030Retained earnings10259Total stockholders' equity152109Total liabilities and stockholders' equity553490Table 4Track Software, Inc.Statement of Retained Earnings ($000)For the Year Ended December 31, 2006Retained earnings balance, January 1, 2006$59Add: Net profits after taxes for 200648Less: Cash dividends on common stock paid during 20065Retained earnings balance, December 31, 2006102Table 5IndustryActualAverageRatio20052006Current ratio1.061.82Quick ratio0.631.10Inventory turnover10.4012.45Average collection period29.6 days20.2 daysTotal asset turnover2.663.92Debt ratio0.780.55Times interest earned ratio3.005.60Gross profit margin32.10%42.30%Operating profit margin5.50%12.40%Net profit margin3.00%4.00%Return on total assets (ROA)8.00%15.60%Return on common equity (ROE)36.40%34.70%Price/earnings (P/E) ratio5.207.10Market/book (M/B) ratio2.102.20With all of these concerns in mind, Stanley set out to review the various data to develop strategies thatwould help to ensure a bright future for Track Software. Stanley believed that as part of this process , athorough ratio analysis of the firm's 2006 results would provide important additional insights.TO DO(a)Upon what financial goal does Stanley semm to be focusing? Is it the correct goal? Whyor why not?(b)Calculate the firm's earnings per share (EPS) for each year, recoginizing that the number ofshares of common stock outstanding has remained unchanged since the firm's inception.Comment on the EPS performance in view of your response in part a.Use the financial presented to determine Track's operating cash flow (OCF) and free cashflow (FCF) in 2006. Evaluate your findings in light of Track;s current cash flow difficulties.(d)Analyze the firm's financial condition in 2006 as it relates to (1) liquidity, (2) activity, (3) debt(4) profitability, and market, using the financial statements provided in Tables 2 and 3 and theratio included in Table 5. be sure to evaluate the firm on a cross sectional basis.(e)What recommedation would you make to Stanley regarding hiring a new software developer?Relate your recommendation here to your response in part a.