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Capstone® Debrief Rubric Report

Table of Contents

How to Use This Report ................................................................................................................................ 2

Sample Report ............................................................................................................................................... 3

The Company Rubric ..................................................................................................................................... 4 ROS ............................................................................................................................................................ 4

EPS (Earnings Per Share) ........................................................................................................................... 5

Contribution Margin ................................................................................................................................. 5

Change in Stock Price ................................................................................................................................ 6

Leverage .................................................................................................................................................... 6

Stock Price ................................................................................................................................................. 7

Bond Rating ............................................................................................................................................... 8

Emergency Loans ...................................................................................................................................... 8

Current Ratio ............................................................................................................................................. 9

Inventory Reserves.................................................................................................................................. 10

Plant Purchases Funded .......................................................................................................................... 11

Accounts Receivable ............................................................................................................................... 12

Accounts Payable .................................................................................................................................... 13

Asset Turnover ........................................................................................................................................ 14

Sales to Current Assets ........................................................................................................................... 14

Overall Plant Utilization .......................................................................................................................... 15

Stock Outs (Company level) .................................................................................................................... 15

Bloated Inventories ................................................................................................................................. 16

Overall Actual vs. Potential Demand ...................................................................................................... 16

Cost Leadership ....................................................................................................................................... 16

Product Breadth ...................................................................................................................................... 17

Market Share Overall .............................................................................................................................. 17

Overall Awareness .................................................................................................................................. 18

Overall Accessibility ................................................................................................................................ 18

Overall Design ......................................................................................................................................... 19

Asset Base ............................................................................................................................................... 19

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The Product Rubric ..................................................................................................................................... 19 Positioning .............................................................................................................................................. 19

Age .......................................................................................................................................................... 20

Reliability ................................................................................................................................................. 20

Price Percentile ....................................................................................................................................... 21

Awareness ............................................................................................................................................... 21

Accessibility ............................................................................................................................................. 22

Customer Survey Score ........................................................................................................................... 22

Potential Share/Average Share ............................................................................................................... 23

Actual Share/Potential Share .................................................................................................................. 23

Plant Utilization ....................................................................................................................................... 24

Automation ............................................................................................................................................. 24

Contribution Margin ............................................................................................................................... 24

Days of Inventory .................................................................................................................................... 24

Promotion Budget ................................................................................................................................... 25

Sales Budget ............................................................................................................................................ 25

R&D Utilization ........................................................................................................................................ 25

Overall Product Evaluation ..................................................................................................................... 25

Summary Rubrics ........................................................................................................................................ 26

How to Use This Report

The Capstone® Debrief Rubric Report offers a comprehensive evaluation of a company and its products.

It is prepared as a rubric, with each item in the report scored on a scale of zero to three: • Excellent – 3 points • Satisfactory – 2 points • Poor – 1 point • Trouble – 0 points

There are seven categories ranging from “Margins & Profitability” to individual products. Each line item is discussed below, beginning with how the item was scored.

To make quick use of the report, scan it for zeros. Find the description below to learn why the company earned a zero. We recommend having a Capstone Courier at your disposal as you interpret the results.

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Sample Report

DEBRIEF REPORT 2013 Ferris C42681

COMPANY RUBRIC Points (0..3)

Margins & Profitability Asset Utilization ROS (Profits/Sales) 0 Asset turnover (Sales / Assets) 1 EPS (Earnings Per Share) 0 Sales to Current Assets 1 Contribution Margin 2 Overall plant utilization 2 Change in Stock Price 0 Total (Max 9) 4 Total (Max 12) 2

Ability to raise growth capital Forecasting Leverage 2 Stock outs 2 Stock price 0 Bloated inventories 2 Bond rating 1 Overall Actual vs. Potential Demand 3 Total (Max 9) 3 Total (Max 9) 7

Sound Fiscal Policies Competitive Advantage Emergency loans 3 Cost leadership 0 Leverage 2 Product breadth 3 Current Ratio 3 Market share 2 Inventory reserves 0 Overall Awareness 2 Plant purchases funded 3 Overall Accessibility 2 Accounts Receivable 2 Overall Design 1 Accounts Payable 2 Asset Base 3 Total (Max 21) 15 Total (Max 21) 10

PRODUCT RUBRIC Cake Cedar Cid Coat Cure Ch Cp Cs Overall Primary Segment Trad Low High Pfmn Size 0 Pfmn Size Positioning 1 3 2 2 2 0 1 1 2 Age 3 3 1 3 3 0 2 1 2 Reliability 0 0 0 0 0 0 0 0 0 Price Percentile 0 1 0 0 0 0 0 0 0 Awareness 2 2 3 3 3 0 2 2 2 Accessibility 2 2 0 2 2 0 2 2 2 CustomerSurveyScore 1 0 3 3 3 0 3 1 2 PotentialShare/Avg 1 1 3 3 3 0 0 0 1 ActualShare/Potential 3 2 3 3 2 0 2 2 2 PlantUtilization 3 3 3 2 2 0 0 0 2 Automation 0 0 1 2 2 0 2 2 1 ContributionMargin 0 0 0 0 0 0 0 0 0 Days of Inventory 2 2 2 1 2 0 0 0 1 Promotion Budget 0 0 3 3 3 0 3 3 2 Sales Budget 0 0 3 3 3 0 2 2 2 R&D Utilization 0 0 0 0 0 0 0 0 0 Total (Max 48) 18 19 27 30 30 0 19 16 21

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The Company Rubric

ROS Return on Sales (Profit/Sales) answers the question, “How much of every sales dollar did we keep as profit?”

Excellent ROS > 8% Satisfactory 4% < ROS <=8% Poor 0% < ROS <= 4% Trouble ROS <= 0%

Between 0% and 4%, while the company is at least making a profit, it is not bringing in sufficient new equity to fund growth. The industry is growing at about 15% per year. The industry consumes about 15% more capacity each year, which arrives in the form of plant expansions and new products. Therefore, as the simulation begins, an average company would add about $12 million in new plant each year. If half that or $6 million was funded with bonds, an average company would need about $6 million in new equity. Therefore, if the company does not have the profits, it must either issue $6 million in new stock, or $12 million in bonds, or not grow to keep up with demand. Worse, if it has no profits, its stock price falls, making it difficult to raise equity through stock issues.

This ignores investments in automation, which also require a funding mix of equity and debt.

In the opening round of Capstone® companies have an excess of assets, and that can convert idle assets into productive ones. Therefore, do not worry too much if the company’s profits are low. But after year 3, expect that idle asset cushion to be gone. Profits become critical because those companies with profits can grow, and those without cannot.

What if profits are negative? The company is destroying equity. Its stock price has plummeted, making it more difficult to raise equity. All of the problems described above are now accelerated. In short, trouble.

How can companies improve ROS? Here are a few questions to pose.

1. Can you raise prices? 2. Can you reduce your labor costs? Your material costs? 3. Can you forecast sales better and thereby reduce your inventory carrying expenses? 4. Have you pushed your promotion or sales budgets into diminishing returns? 5. Can you sell idle plant to reduce depreciation? Alternatively, can you convert idle plant into

some other productive asset, like automation or new products? 6. Is your leverage too high, resulting in high interest expenses. (See leverage.)

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EPS (Earnings Per Share) EPS (profits/shares outstanding) answers the question, “What profits did each share earn?” EPS is a driver of stock price, and stock issues are an important source of growth capital.

Excellent EPS > $2 + Round # Satisfactory ($2 + Round #)/3 < EPS <= $2 + Round # Poor $0.00 < EPS < ($2 + Round #)/3 Trouble EPS <= $0.00

In the table, “Round #” refers to the year in the Capstone®. Round 1 is year 1, round 2 is year 2. The market is growing, and so should profits. In Round 5, for example, an excellent EPS would be ($2 + $5) = $7.00 per share, and a satisfactory EPS would be at least 1/3 that or $2.33.

EPS is important for three reasons. First, profits bring new equity into the company. Second, EPS drives stock price, and the company can issue shares to bring in new equity. Third, any new equity can be leveraged with new debt.

An example may help. Suppose the company wants to invest $15 million in new plant and equipment each year for the next three years. If its profits are zero and it issues no stock, the purchases would need to be funded entirely with bonds. But this would drive up interest expense, and worse, eventually the company would reach a ceiling where bond holders would give it no additional debt. The company would stop growing.

In the end, a company’s growth is built upon equity. If it has equity, it can get debt, too.

How can companies improve EPS? Improve sales volume while maintaining margins. EPS is closely linked with the Asset Utilization and Competitive Advantage categories.

Contribution Margin Contribution margin is what is left over after variable costs. Variable costs include the cost of goods (material and labor) and inventory carrying expense.

The biggest expense is the cost of goods. If the contribution margin is 30%, then out of every sales dollar, $0.70 paid for inventory and $0.30 is available for everything else, including profits.

Excellent Contribution Margin > 35% Satisfactory Contribution Margin > 27% Poor Contribution Margin > 22% Trouble Contribution Margin < 22%

Fixed costs are those expenses that will be paid regardless of sales. They include promotion, sales budget, R&D, admin, and interest expenses.

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As the contribution margin falls below 30%, it becomes increasingly difficult to cover fixed costs.

How can a company improve its contribution margin? Guard price and attack material and labor expenses.

Change in Stock Price The change in stock price from one year to the next is an indicator for the long term growth potential of the company.

Excellent > $20.00 Satisfactory > $7.00 Poor > - $5.00 Trouble < - $5.00

If the stock price is increasing, the company will enjoy easier access to new equity via profits and stock issues, which in turn can be leveraged with additional bonds, and the combined capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital, either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Leverage In Capstone® Leverage is defined as Assets/Equity. (It is sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question, “How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio, the more debt is in the mix.

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as, “There are $3 of assets for every $1 of equity.”

Excellent 1.8 < Leverage < 2.5 Satisfactory 1.6 < Leverage <1.8 , or 2.5 < Leverage < 2.8 Poor 1.4 < Leverage <1.6, or 2.8 < Leverage < 3.2 Trouble Leverage < 1.4, or Leverage > 3.2

It is easy to see why too much Leverage can cause problems. As debt increases, loans become more expensive. The company becomes high risk, and lenders eventually decline to lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base than their competitors. For example, a broad product line implies a larger plant. A highly automated facility implies a large investment. Growing the company’s asset base quickly calls for prudent use of debt.

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Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million. Assume that each team is utilizing their assets productively. An observer will bet on Baldwin because its larger asset base translates into more products or more productivity. Now suppose that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity. By leveraging its equity, Baldwin gained an advantage.

Too little leverage can also indicate weakness, provided that investment opportunities exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are out of ideas for investments. The best we can come up with is to save you the interest on debt.” This will not impress stockholders, who are looking for a high return on their equity (ROE). An investor expecting a 20% ROE will be unhappy learning that their money was used to reduce debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the company can somehow hold its margins and productivity constant, increasing leverage improves ROE.

If leverage is falling, here are some things to suggest to the company.

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already at a high plant utilization, you will need to add some capacity each year. Or perhaps you can add a new product. Fund these investment opportunities with a mix of debt and equity consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that you have excess working capital that cannot be put to good use. In the real world management might get into new businesses, but in Capstone® there are no such alternatives. In this case, make your stockholders happy by buying back stock or paying dividends to maintain the leverage.

Stock Price Stock price is a function of book value, EPS and the number of shares outstanding. Book value sets a floor, although negative earnings can depress stock price below book. Stock price can also be negatively impacted by emergency loans. In the absence of losses and emergency loans, Capstone’s stock price is primarily a function of past and present EPS.

Excellent Stock price > $40 + 5 * Round number Satisfactory Stock price > $25 + 5 * Round number Poor Stock price > $10 + 5 * Round number Trouble Stock price < $10 + 5 * Round number

In the table, “Round Number” refers to the year in the Capstone®. Round 1 is year 1, round 2 is year 2. The market is growing, and so should profits. As time passes and EPS increases, we should expect stock price to increase.

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Stock price is important because, ultimately, equity drives the company’s ability to raise capital for growth. Even if it never issues a share, a rising stock price means it is accumulating profits as retained earnings. More equity means that it can raise additional debt, and together its mix of debt and equity fuels the company’s growth.

Also see the discussion for EPS and Leverage.

Bond Rating The bond ratings are, from best to worst, AAA, AA, A, BBB, BB, B, CCC, CC, C, DDD. Bond ratings are driven by leverage. As bond ratings fall, interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt. This sets a limit on the company’s ability to acquire additional assets, particularly automation, capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity. Companies can improve their bond rating by adding equity, either as a stock issue or as profits. The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing debt also implies shrinking the asset base. While there are always exceptions to the rule, shrinking the asset base in a growing market would be limiting to growth.

Excellent AAA, AA, A Satisfactory BBB, BB, B Poor CCC, CC, C Trouble DDD

Emergency Loans If a company is out of cash on December 31st, a character in the simulation, Big Al, arrives to give it just enough money to bring its cash balance to zero. The company pays Big Al its short term interest rate plus a 7.5% premium. Stock price also falls – how much depending upon the severity of the loan.

Excellent No emergency loan Satisfactory Emergency loan less than $1 million Poor Emergency loan less than $8 million Trouble Emergency loan greater than $8 million

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The great majority of emergency loans are rooted in three mistakes.

1. The company purchased a plant, but did not fund it adequately. 2. The company forecasted too much demand, and when it did not materialize, its inventory

expansion exceeded reserves. 3. The company neglected to fund your current assets adequately, usually because it brought its

current debt to zero.

You can also direct students to the online Team Member Guide, and the Analyst Report, where emergency loans are also discussed at some length.

While painful, an emergency loan that purchased assets is not destructive so long as the assets are useful. After all, the company could have and should have funded the assets with cheaper debt. It now has an asset at its disposal, even though it overpaid for it.

However, there is another cause of emergency loans – sustained negative profits. The company is, well, a zombie, kept in motion by transfusions from the deep pockets of Big Al. The only advice we can offer here is, intervene before the company joins the walking dead. If profits are negative two years in row, intervene to improve margins and reverse the trend.

Current Ratio Current Ratio is defined as Current Assets/Current Liabilities, which in turn is (Cash + A/R + Inventory) / (A/P + Current Debt). From a banker and vendor’s point of view, it answers the question, “How likely am I to get my money back?”

Excellent 1.8 < Current Ratio <= 2.2 Satisfactory 1.6 < Current Ratio <=1.8, or 2.2 < Current Ratio <= 2.4 Poor 1.3 < Current Ratio <=1.4, or 2.4 < Current Ratio <= 2.7 Trouble Current Ratio < 1.3, or Current Ratio > 2.7

Like any asset, current assets are paid for with a mix of debt and equity. The debt is Accounts Payable and Current Debt, which we can think of as “short term funding”. The balance is “long term funding”, and it is probably equity, but it could be long term debt. More precisely this long term funding is Working Capital, which is defined as Current Assets – Current Liabilities.

What should the Current Ratio be? While that is a policy decision, we suggest starting with the debt/equity mix of the entire company. If the mix is 50/50 overall, why would the company have a different policy for Current Assets? If Current Assets are funded half with Current Liabilities and half with equity, then the Current Ratio is 2.0.

Where does trouble begin? A Current Ratio of 1.0 says that Current Assets are funded entirely with Current Liabilities. Bankers and Vendors are very worried, and are likely to withhold additional funding. They do not begin to relax until the ratio reaches 1.3, which in effect says for every $1.30 of current assets they fund $1.00. By 1.6 they remain watchful but are less concerned, and at 1.8 they are happy to lend money or offer credit.

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However, trouble exists at the high side, too. A Current Ratio of 3.0 says that the company has $3.00 of assets for every $1.00 of debt, and therefore $2.00 of current assets are being funded with long term money. But if long term money is tied up with current assets, it cannot be used to fund long term assets – capacity, automation, and new products.

Consider a stockholder. The stockholder knows that he/she gets no return on current assets. Stockholders make no return on Cash, on Accounts Receivable, or on inventory. In some sense they are necessary evils. Stockholders recognize the necessity of current assets, but if they expect a 20% return on their investment, they would rather the company borrow money from a bank at 10% so their money can be invested in wealth producing assets – capacity, automation, and new products. A stockholder wants to see a low Current Ratio, while vendors want to see a high Current Ratio.

It follows from this reasoning that paying current debt to $0 is a mistake. The question companies must answer is, “How much current debt should be in the mix?”

In the real world, bankers will typically fund up to 75% of Accounts Receivable and 50% of inventory. Using this as a rule of thumb, here is a quick method to arrive at Current Debt before a company saves decisions.

1. Drive the proforma financial statements into a “worst case scenario”. In the worst case, the pessimistic unit sales forecast is put into the Marketing worksheet, and the best case unit sales forecast into the Production schedule. In the worst case, the proforma balance sheet ‘s inventory is at a maximum.

2. Looking at the proforma balance sheet, calculate 50% of the inventory and 75% of the Receivables.

3. On the Finance sheet, enter the result as Current Debt for next year.

Companies will discover that if its policy towards A/R is 30 days, its policy towards inventory is 90 days, and it has $1 of cash, then a policy of A/P at 30 days, and current debt at 75% of A/R and 50% of inventory, will give it a Current Ratio of about 2.0.

Inventory Reserves Inventory expansions are the number one cause of emergency loans. This can be further broken down into two root causes – forecasting, and inadequate inventory reserves.

By inventory reserves we mean, “How much inventory are we willing to accumulate during the year in our worst case?” We express this as “days of inventory.”

Suppose the gross margin is 30%. If so, then the cost of inventory consumes 70% of every sales dollar. If sales are $100 million, over the course of a year the company spends $70 million on inventory. In one day it spends $191 thousand. In 30 days it spends $5.7 million. In 90 days $17.3 million.