Instructions for Blockbuster

Effective 2005, Blockbuster began a new policy of no late fees. In late 2005, Blockbuster was experiencing financial distress and needed emergency financing to stay afloat. The stock price dropped from $12 to $4, and the debt traded as junk.Question 1: Analyze the soundness of the decision, given the contribution that late fees made to prior years’ results. Does an analysis of the company’s cash flows support or refute the company’s decision?What you need to do is as follows: Get the data from 2002-2004, which should all be in the 2004 10-k, compute what free cash flow would have been without the late fees during 2002-2004, and project what 2005 free cash flow would be if the no late fee policy stays in place and business doesn’t improve. Late fees are referred to by the euphemism â€Å"extended viewing fees†.Question 2: Is there any evidence that the 2005 results benefited from the no-late fees policy? If so, quantify the specific amount you believ e that the basic business improved due to the no late fees.Compare your projected 2005 free cash flow to the actual (from the 2005 10-k). Consider the known reasons that 2005 results differed from the no-late expectation from question 1: i) there were some large fees actually collected, ii) interest costs were higher than expected, iii) Capex was way lower than any reasonable expectation, and iv) a lot of cash went into working paper to replace the trade credit that was withdrawn. Use these four ‘known unexpecteds’ to form an adjusted expectation for 2005, and then compare that number to the actual.Notes: 1. It is important to remember the effects of tax. In particular, free cash flow should change by the after-tax amount of late fees, not by the gross amount of late fees. 2. Late fees are referred to in the income statement by the euphemism â€Å"extended viewing fees†. 3. Focus on Blockbuster’s data and  don’t get distracted by an analysis of Ne tflix. Avoid making testimonials about how much better Netflix is than Blockbuster, or vice versa.