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BA 3303 - Foundations of Finance Review for Exam 4 Chapters 11 - 14 Exam 4 will be given Wednesday, August 3, 2011 PowerPoint PPT Presentation


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BA 3303 - Foundations of Finance Review for Exam 4 Chapters 11 - 14 Exam 4 will be given Wednesday, August 3, 2011. Exam 4 – Questions Distribution. Forms of Business Own’p Sole Proprietorship Partnership Corporation. Oprns. ( Etc. ). Sales. Finance. Acctg. 6. 10.

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BA 3303 - Foundations of Finance Review for Exam 4

Chapters 11 - 14

Exam 4 will be given

Wednesday, August 3, 2011


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Exam 4 – Questions Distribution

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

6

10

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

6

7

5

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Categories

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value

3

3

9

Other: 1


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Those

who need

money

Those

who have

money

“Finance” – What It Is

(2)

(3)

$$

(1)

(4)

A promise of

something of

value

MONEY

&

SAVINGS

USES

OF

MONEY

(5)

* Checking accts, savings

accts, investment funds,

insurance premiums,

pension funds

* For personal use: consumables,

durables, cars, houses, etc.

* For business use: buildings,

equipment, inventory, etc.

(1)Making money available and accumulating it …

(2)… then getting that money from those who have it …

(3)… to those who need it …

(4)… so that they can put it to use.

(5)In return, those who receive the money promise

something of value to those who provided it.


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The 3 Sections of the Textbook

PART 1

Institutions &

Markets

PART 2

PART 3

Financial

Management

Investments

PART 1: Institutions = organizations and

intermediaries that: (1) help accumulate savings,

and (2) get those funds to individuals, businesses,

and governments that will spend or invest them.

Markets = forums that facilitate the flow

of funds among individuals, businesses, and

government.

PART 2: Investments = the analysis, valuation,

and sale of securities, and the management of

the associated risk.

PART 3: Financial Management = financial

planning, asset management, and fund-raising

decisions for a business.


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Financial Management

  • Involves business people working

  • with financial institutions and

  • markets.

  • Involves business reporting, which

  • provides investors, management,

  • and the government info about the

  • financial health and direction of the

  • company.

  • Involves assessing projects for

  • viability and profitability, which

  • takes into account interest rates,

  • risk, stock prices, etc.

  • Involves getting funds via stocks

  • and bonds issued to the public.


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How the “Parts of the Text” Relate

to the “Business Framework”

Part 1

Lenders

Owners /

Investors

Government

Environment

Employees

Part 2

* Production * Mgmt

* Sales * IT * Logistics

* R&D * Mktg * Facil. Mgmt

* HR * Purchasing * Finance

* Accounting

Part 3

Neighbors

Customers

Competitors

Suppliers

Part 1 = “Institutions & Markets”

Part 2 = “Investments”

Part 3 = “Financial Management”


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Financial Management

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Types

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value


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CHAPTER 11

Business Organization and Financial Data


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Financial Management

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Types

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value


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Business Ownership

Factors:

Which Form

of Business?

Source

of

Funding

Legal

Liability &

Risk

Allocation

of

Profits

Managerial

Control


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Forms of Business Ownership

Forms of

Ownership

(1)

(2)

(3)

Sole

Proprietorship

Corporation

Partnership

* 72% of Firms

* 5% of Revenues

* 8% of Firms

* 10% of Revenues

* 20% of Firms

* 85% of Revenues

(1) Sole Proprietorship = “Business venture that is

owned by a single individual, who personally

receives all profit and assumes all responsibility

for the debts and losses of the business.”

(2) Partnership =“Form of business organization

in which 2 or more people own a business operated

for profit.” They share in profits and liabilities.

(3) Corporation =“Legal entity created under state

law with unending life that offers limited financial

liability to its owners.”


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Forms of Business Ownership

= “Strength”

= “Weakness”


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Income Statement - p. 302 in text

“Revenues & Expenses”

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Income to

Bond holders

Corporate Income Tax

Belongs to

Stock holders,

or Owners

Personal Income Tax

One of 3 things can be done with the Earnings:

(1) Pay it to Stock holders as income = “Dividend”

(2) Retain it, and reinvest it in the company

(3) Retain it, and hold it as cash or securities


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Financial Management

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Types

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value


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Annual Report

Annual Report: “Contains descriptive

information and numerical records on

the operating and financial performance

of a firm during the past year”

Operations

& Financial

Hilights

Business

Opportunities

& Goals

Annual

Report

Financial

Reports

Statement

of Cash

Flows

Income

Statement

Balance

Sheet


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Financial Reports

Financial

Reports

(1)

(2)

(3)

Statement

of Cash

Flows

Income

Statement

Balance

Sheet

* “Revenues &

Expenses”

* Operating info

over time period

* “Assets &

Liabilities”

* Snapshot at end

of time period

* “Sources (Inflows)

& Uses (Outflows)

of Cash”

* Change from prev.

time period

(1) Income Statement = “Reports the revenues

generated & expenses incurred by a firm over an

accounting period.” Accrual method… remember?

(2) Balance Sheet =“A statement of a company’s

financial position as of a particular date.”

(3) Statement of Cash Flows =“Provides a summary

of cash inflows (sources) and outflows (uses)

during a specified reporting period.”


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ACCOUNTING:

Focuses on “accrual

method” = revenues

and corresponding

expenses are

recognized when a

sale occurs.

FINANCE:

Focuses on “cash

flows” = when cash

revenues are received

and cash expenses

are paid.

Income Statement

“Revenues & Expenses”

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Income to

Bond holders

Belongs to

Stock holders,

or Owners

One of 3 things can be done with the Earnings:

(1) Pay it to Stock holders as income = “Dividend”

(2) Retain it, and reinvest it in the company

(3) Retain it, and hold it as cash or securities


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Income Statement - p. 302 in text

“Revenues & Expenses”

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Income to

Bond holders

Belongs to

Stock holders,

or Owners

One of 3 things can be done with the Earnings:

(1) Pay it to Stock holders as income = “Dividend”

(2) Retain it, and reinvest it in the company

(3) Retain it, and hold it as cash or securities


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ACCOUNTING:

Depreciates assets

according to set

schedules, so that their

accounting value

decreases over time.

FINANCE:

Also interested in

the actual and

replacement value.

Balance Sheet

“Assets & Liabilities”

Assets

Current

Assets

Fixed

Assets

“Financial and physical

items owned by a bus.”

Expected life is

> 1 year.

Expected to be turned

into Cash < 1 year.

Liabilities

Current

Liabilities

“Creditors’ claims

on a firm.”

Long-Term

Liabilities

Expected to be

paid < 1 year.

Expected to be

paid > 1 year.

Owner’s

Equity

Preferred

Equity

Retained

Earnings

“Funds supplied by the owners

that represent their residual

claim in the firm.”

Common

Equity


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Balance Sheet

“Assets & Liabilities”

Assets

Current

Assets

Fixed

Assets

“Financial and physical

items owned by a business.”

Expected life is

> 1 year.

Expected to be turned

into Cash < 1 year.

Liabilities

Current

Liabilities

“Creditors’ claims

on a firm.”

Long-Term

Liabilities

Expected to be

paid < 1 year.

Expected to be

paid > 1 year.

Owner’s

Equity

Preferred

Equity

Retained

Earnings

“Funds supplied by the owners

that represent their residual

claim in the firm.”

Common

Equity


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Balance Sheet – p. 304 in text

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

“Assets” - “Liabilities” = “Owners Equity”


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Statement of Cash Flows

“Sources & Uses”

Statement

of Cash Flows

(1)

(2)

(3)

Operating

Activities

Investing

Activities

Financing

Activities

(1) Operating Activities = the actual making and

selling of the product.

(2) Investing Activities =the purchasing and

disposition of fixed assets.

(3) Financing Activities =the funding of the

firm’s activities.


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Cash Flow Determination

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Net Profit (or Earnings, or NIAT) is a good starting point for determining Cash Flow coming into the company. BUT, it is not totally accurate…


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Cash Flow Determination

INCOME STATEMENT:

Revenues Cash flow different?

< Cost of Goods Sold >Cash flow different?

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >NOT a cash outflow!!

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT


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Cash Flow Determination

INCOME STATEMENT:

Revenues Cash flow different?

< Cost of Goods Sold >Cash flow different?

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >NOT a cash outflow!!

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

EXAMPLE:

$100,000 Sales (Revenues)

$ 75,000 Payments (cash in)

$ 25,000 Increase in

“Accts Receivable”

EXAMPLE:

$ 50,000 Inventory Cost (COGS)

$ 40,000 Payments (cash out)

$ 10,000 Increase in

“Accts Payable”

  • Income Statement:

  • “Revenues” overstates “CASH IN” by $25k

  • “Cost of Goods Sold” overstates “CASH OUT” by $10k

  • So, we must assess the Balance Sheet accounts to

  • determine how much to adjust the IS numbers…


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Cash Flow Determination - EXAMPLE

INCOME STATEMENT:

Revenues$100,000

< Cost of Goods Sold > < $ 50,000 >

Gross Profit $ 50,000

< Other Expenses > < $ 20,000 >

< Depreciation > < $ 10,000 >

Operating Income (or EBIT) $ 20,000

< Interest > < $ 5,000 >

Net Inc. Before Taxes (NIBT) $ 15,000

< Taxes > < $ 3,000 >

Net Profit, Earnings, NIAT $ 12,000

So, these are the payments / receipts for the period:

CASH INCASH OUTTOTAL

Cash rec’vd for Sales: 75,000

“Accts Rec’v” payments: 15,000

Cash paid for materials: < 40,000 >

“Accts Payable” payments: < 30,000 >

. . . .

TOTAL: 90,000 < 70,000 > 20,000


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Cash Flow Determination - EXAMPLE

INCOME STATEMENT:

Revenues$100,000

< Cost of Goods Sold > < $ 50,000 >

Gross Profit $ 50,000

< Other Expenses > < $ 20,000 >

< Depreciation > < $ 10,000 >

Operating Income (or EBIT) $ 20,000

< Interest > < $ 5,000 >

Net Inc. Before Taxes (NIBT) $ 15,000

< Taxes > < $ 3,000 >

Net Profit, Earnings, NIAT $ 12,000

So, these are the payments / receipts for the period:

CASH INCASH OUTTOTAL

Cash rec’vd for Sales: 75,000

“Accts Rec’v” payments: 15,000

Cash paid for materials: < 40,000 >

“Accts Payable” payments: < 30,000 >

. . . .

TOTAL: 90,000 < 70,000 > 20,000


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Cash Flow Determination - EXAMPLE

INCOME STATEMENT:

Revenues$100,000

< Cost of Goods Sold > < $ 50,000 >

Gross Profit $ 50,000

< Other Expenses > < $ 20,000 >

< Depreciation > < $ 10,000 >

Operating Income (or EBIT) $ 20,000

< Interest > < $ 5,000 >

Net Inc. Before Taxes (NIBT) $ 15,000

< Taxes > < $ 3,000 >

Net Profit, Earnings, NIAT $ 12,000

So, these are the payments / receipts for the period:

CASH INCASH OUTTOTAL

Cash rec’vd for Sales: 75,000

“Accts Rec’v” payments: 15,000

Cash paid for materials: < 40,000 >

“Accts Payable” payments: < 30,000 >

. . . .

TOTAL: 90,000 < 70,000 > 20,000


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Cash Flow Determination - EXAMPLE

BALANCE SHEET : PREVIOUSCHANGE CURRENT

* Cash & Marketable Securities

* Accounts Receivable 50,000 10,000 60,000

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable 40,000 < 20,000 > 20,000

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

25,000 – 15,000

Increase in Asset Acct is Cash Out (“Use”)

10,000 – 30,000

Decrease in Liability Acct is Cash Out (“Use”)

TOTAL CASH ADJUSTMENT:

10,000 + 20,000 = 30,000 “out”

So, these are the payments / receipts for the period:

CASH INCASH OUTTOTAL

Cash rec’vd for Sales: 75,000

“Accts Rec’v” payments: 15,000

Cash paid for materials: < 40,000 >

“Accts Payable” payments: < 30,000 >

. . . .

TOTAL: 90,000 < 70,000 > 20,000


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Cash Flow Determination - EXAMPLE

INCOME STATEMENT:

Revenues$100,000

< Cost of Goods Sold > < $ 50,000 >

Gross Profit $ 50,000

< Other Expenses > < $ 20,000 >

< Depreciation > < $ 10,000 >

Operating Income (or EBIT) $ 20,000

< Interest > < $ 5,000 >

Net Inc. Before Taxes (NIBT) $ 15,000

< Taxes > < $ 3,000 >

Net Profit, Earnings, NIAT $ 12,000

TOTAL CASH ADJUSTMENT:

10,000 + 20,000 = 30,000 “out”

So, these are the payments / receipts for the period:

CASH INCASH OUTTOTAL

Cash rec’vd for Sales: 75,000

“Accts Rec’v” payments: 15,000

Cash paid for materials: < 40,000 >

“Accts Payable” payments: < 30,000 >

. . . .

TOTAL: 90,000 < 70,000 > 20,000


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Cash Flow Determination

Cash Flows Determined By:

Sources of

. Cash .

< Uses of

. Cash > .

Asset Acct

Liability Acct

Equity Acct

< Cash Div. >

< Increase >

< Decrease >

< Decrease >

+ Net Income

+ Depreciation

+ Decrease

+ Increase

+ Increase

NOTE: the net Cash Flow will equal the change in the “Cash Account” from the previous Balance Sheet.


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Cash Flow Determination - EXAMPLE

INCOME STATEMENT:

Revenues$100,000

< Cost of Goods Sold > < $ 50,000 >

Gross Profit $ 50,000

< Other Expenses > < $ 20,000 >

< Depreciation > < $ 10,000 >

Operating Income (or EBIT) $ 20,000

< Interest > < $ 5,000 >

Net Inc. Before Taxes (NIBT) $ 15,000

< Taxes > < $ 3,000 >

Net Profit, Earnings, NIAT $ 12,000

Sources.

.< Uses > .

Asset Acct

Liability Acct

Equity Acct

< Cash Div. >

< Increase >

< Decrease >

< Decrease >

+ Net Income

+ Depreciation

+ Decrease

+ Increase

+ Increase


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Cash Flow Determination - EXAMPLE

BALANCE SHEET : PREVIOUSCHANGE CURRENT

* Cash & Marketable Securities

* Accounts Receivable 50,000 10,000 60,000

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable 40,000 < 20,000 > 20,000

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

Sources.

.< Uses > .

Asset Acct

Liability Acct

Equity Acct

< Cash Div. >

< Increase >

< Decrease >

< Decrease >

+ Net Income

+ Depreciation

+ Decrease

+ Increase

+ Increase


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Statement of Cash Flows – p. 307 in text

* Net Income or < Loss >

* Depreciation

* Decrease or < Increase > in Current Asset accts

* Increase or < Decrease > in Current Liability accts

CASH FROM OPERATING ACTIVITIES

* Sale or < Purchase > of Property, Plant,

. Equipment, etc. .

CASH FROM INVESTING ACTIVITIES

* Issuance or < Repurchase > of Stock

* Increase or < Decrease > in Long-Term Debt

* < Dividends > .

CASH FROM FINANCING

NET CHANGE IN CASH

Income Stmt, &

“Current” Accts

Fixed Assets

Long Term Liabilities

& Owners Equity


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Financial Statements

-- Applied to Personal Scenario --

A personal budget scenario…

  • You make $30,000 per year ($2,500 / mo)

  • You have $1,200 / mo in expenses

  • You are paying off 2 loans: $300 / mo

  • each for a student loan and for a car

  • loan

  • You have already saved $6,000 for a Rainy

  • Day fund

  • You invest $300 / mo in a Roth IRA


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Financial Statements

-- Applied to Personal Scenario --


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Financial Statements

-- Applied to Personal Scenario --


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Financial Statements

-- Applied to Personal Scenario --

A personal budget scenario…

  • You make $30,000 per year ($2,500 / mo)

  • You have $1,200 / mo in expenses

  • You are paying off 2 loans: $300 / mo

  • each for a student loan and for a car

  • loan

  • You have already saved $6,000 for a Rainy

  • Day fund

  • You invest $300 / mo in a Roth IRA

What if you charged your $1,200 of expenses to a credit card, and did not pay it off in full?


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Financial Statements

-- Applied to Personal Scenario --


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Financial Statements

-- Applied to Personal Scenario --


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Charging to a Credit Card and

Not Paying It Off in Full

Reasons

To Not

Charge…

Higher

Standard

of Living

Still

Need to Pay

It Off

Paying

More Due to

Interest

Extra

Cash to

Spend


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Charging to a Credit Card and

Not Paying It Off in Full

Look at Financial Statement example…

PV = $1200 expenses put on credit card

I/Y = 1.5% ( assume 18% annual rate )

FV = 0

PMT = - $25 per month

CPT [ N ] = 85.5 months

Therefore, total paid for the $1200 is…

$25 x 85.5 = $2137.48

What if you make a $50 per month payment…

CPT [ N ] = 30.0 months

Therefore, total paid for the $1200 is…

$50 x 30.0 = $1500


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Charging to a Credit Card and

Not Paying It Off in Full

Look at Wannemacher’s real statement…

PV = $3503.95 expenses put on credit card

I/Y = 13.24 / 12 = 1.1% monthly interest rate

FV = 0

PMT = - $25 per month (my minimum payment)

CPT [ N ] = Error 5

The “Minimum Payment” of $25 isn’t even

enough to cover the Interest!! The balance would

grow infinitely…

What if I made a $50 per month payment…

CPT [ N ] = 135.2 months

Therefore, total paid for the $3503.95 is…

$50 x 135.2 = $6,760.74


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FICO Credit Score Components

Source: www.myfico.com

http://www.myfico.com/crediteducation/WhatsInYourScore.aspx

AMOUNT OWED:

o Revolving are more

heavily weighted

o %-age of credit limit

borrowed (each card

& total)

LENGTH OF CREDIT HISTORY:

o Time since accts opened

o Time since acct activity

NEW CREDIT:

o Opening multiple new accts

o Lenders checking

your score

15%

10%

30%

10%

35%

“CREDIT MIX”:

o Vague

o Mix of Revolving &

Installment is good

PAYMENT HISTORY:

o Repayment of past debt:

-- Revolving (“credit card”)

-- Installment (“loans”)

Credit Score (300 – 850) Assessments

Source: www.easybadcreditrepair.com

SCORE: ASSESSMENT:

750+ Excellent

720 - 749 Good

660 – 719 Fair

620 – 659 Uncertain

Less than 620 Poor


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CHAPTER 12

Financial Analysis and

Long-Term Planning


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Financial Management

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Types

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value


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Ratio Analysis

CAUTION: A “Ratio” by itself is essentially

worthless – it must be compared to another

Ratio. Even then… BE CAREFUL!

Categories

of Ratio

Analysis

(1)

(2)

(3)

“Trend”

Or Time Series

Analysis

Industry

Comparative

Analysis

Cross-

Sectional

Analysis

* Compare to self

from previous

periods.

* Compare to

industry

average.

* Compare to

other firms’

ratio.


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Types of Financial Ratios

(2)

Asset

Management

Ratios

(3)

(1)

Financial

Leverage

Ratios

Liquidity

Ratios

Types

Of

Ratios

(4)

(5)

Market

Value

Ratios

Profitability

Ratios

* The first 4 use Income Stmt & Balance Sheet data.

* The “Market Value Ratios” relates stock market info

to financial statement items.


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Types of Financial Ratios


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BALANCE SHEET :

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

Types of Financial Ratios


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Types of Financial Ratios


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Types of Financial Ratios

BALANCE SHEET :

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT


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Types of Financial Ratios


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Types of Financial Ratios

BALANCE SHEET :

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

Debt-Related Items

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT


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“Financial Leverage” -- EXAMPLE

Premise: I have $100,000 to

invest in rent houses

# of

$100k

Houses

1

2

10

$$ /

House

Borr’d

$0

$50k

(total

$100k)

$90k

(total

$900k)

Total

House

Value

$100k

$200k

$1MM

20%

Value

Incr.

$20k /

$100k

(+20%)

$40k /

$100k

(+40%)

$200k /

$100k

(+200%)

20%

Value

Decr.

-$20k /

$100k

(-20%)

-$40k /

$100k

(-40%)

-$200k /

$100k

(-200%)

My $$ /

House

$100k

(total

$100k)

$50k

(total

$100k)

$10k

(total

$100k)


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“Financial Leverage” -- EXAMPLE

Balance Sheet:

# of $100k

Houses:

Assets:

Liabilities:

“Owner’s Equity”

(ie, “Net Worth”)

1

$100k

$ 0k

$100k

2

$200k

$100k

$100k

10

$1MM

$900k

$100k

“Debt Ratio” = Liab / Assets: 0 .5 .9

o There are costs associated with liabilities

(interest, repayment of amount, etc.).

o “Reducing one’s balance sheet” means

eliminating liabilities (and assets), resulting

in less obligations for the company.


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Types of Financial Ratios


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Types of Financial Ratios

BALANCE SHEET :

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

Earnings-Related Items

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT


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Types of Financial Ratios


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Types of Financial Ratios

BALANCE SHEET :

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

STOCK PRICE (from External)


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Financial Ratios Analysis

-- “DDD” EXAMPLE


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“Once Upon a Time…”

-- Chaquita Brands Strategy --

WSJ April 6, 2010:

“Chaquita Brands’ Strategy

Proves Fruitful”

Chaquita Brands Int’l stock maxed out in 2005.

Changes to the European quota system made bananas less profitable.

Since then, Chaquita has stopped selling fruit to some unprofitable buyers, and has a fuel surcharge to cover shipping costs.

They are now making money.

Chaquita trades at 7 times earnings (ie, “price / earnings ratio” is 7)

Their competitors Dole Food and Del Monte Produce have a Price / Earnings Ratio of about 8.


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Types of Financial Ratios


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“Once Upon a Time…”

-- Ford Slashes Debt --

WSJ April 6, 2010:

“Ford Slashes Debt with $4B

Outlay to UAW…”

Ford Motor will pay $3.8B in cash to a United Auto Workers (UAW) union health care fund, confident the company will produce profits.

Ford was required to pay $859MM in cash or stock, and prepaid $2.9B more in cash.

The $3.8B payment will reduce the balance owed to the UAW to $3.6B.

Ford has reduced debt by $7B in the quarter, reducing annual interest payments by $470MM.

An analyst says “Ford still has a dirty balance sheet” – it has more debt than rivals like GM.

Ford had borrowed $23B in late 2006, giving a cash cushion that allowed them to withstand losses and avoid bankruptcy (unlike GM).


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Balance Sheet – p. 304 in text

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

$7B

$7B

No change…

“Assets” - “Liabilities” = “Owners Equity”


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Income Statement - p. 302 in text

“Revenues & Expenses”

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

$470MM

$470MM

Belongs to

Stock holders,

or Owners

One of 3 things can be done with the Earnings:

(1) Pay it to Stock holders as income = “Dividend”

(2) Retain it, and reinvest it in the company

(3) Retain it, and hold it as cash or securities


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“Once Upon a Time…”

-- Blockbuster --

DMN August 14, 2010:

“Blockbuster Posts Bigger Loss,

Says Chapter 7 Filing Possible”

  • Blockbuster Inc. (BB) had larger than expected 2nd quarter loss, as revenue decreased.

  • Revenue fell 20% to $788MM from $982MM.

  • However, BB’s senior secured debt holders gave extension to Sept 30 on the $42MM interest payment due. It is the second extension.

  • In its quarterly filing to the SEC, BB says Ch 7 bankruptcy (liquidation) is possible, Ch 11 (reorg) is required.

  • In July, BB’s cash balance was $64.3MM, down from $109.9MM in April , and down from $188.7MM in January.

  • BB had net loss of $69MM, or 32 cents / share in 2nd quarter… compared to $37MM loss (21 cents / share) a year ago.


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Income Statement - p. 302 in text

“Revenues & Expenses”

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

$194MM

$42MM

$42MM

Belongs to

Stock holders,

or Owners

One of 3 things can be done with the Earnings:

(1) Pay it to Stock holders as income = “Dividend”

(2) Retain it, and reinvest it in the company

(3) Retain it, and hold it as cash or securities


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“Once Upon a Time…”

-- Blockbuster --

DMN August 14, 2010:

“Blockbuster Posts Bigger Loss,

Says Chapter 7 Filing Possible”

  • Blockbuster Inc. (BB) had larger than expected 2nd quarter loss, as revenue decreased.

  • Revenue fell 20% to $788MM from $982MM.

  • However, BB’s senior secured debt holders gave extension to Sept 30 on the $42MM interest payment due. It is the second extension.

  • In its quarterly filing to the SEC, BB says Ch 7 bankruptcy (liquidation) is possible, Ch 11 (reorg) is required.

  • In July, BB’s cash balance was $64.3MM, down from $109.9MM in April , and down from $188.7MM in January.

  • BB had net loss of $69MM, or 32 cents / share in 2nd quarter… compared to $37MM loss (21 cents / share) a year ago.


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Types of Financial Ratios


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“Once Upon a Time…”

-- Blockbuster --

DMN August 14, 2010:

“Blockbuster Posts Bigger Loss,

Says Chapter 7 Filing Possible”

  • Blockbuster Inc. (BB) had larger than expected 2nd quarter loss, as revenue decreased.

  • Revenue fell 20% to $788MM from $982MM.

  • However, BB’s senior secured debt holders gave extension to Sept 30 on the $42MM interest payment due. It is the second extension.

  • In its quarterly filing to the SEC, BB says Ch 7 bankruptcy (liquidation) is possible, Ch 11 (reorg) is required.

  • In July, BB’s cash balance was $64.3MM, down from $109.9MM in April , and down from $188.7MM in January.

  • BB had net loss of $69MM, or 32 cents / share in 2nd quarter… compared to $37MM loss (21 cents / share) a year ago.


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Types of Financial Ratios


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“Once Upon a Time…”

-- Blockbuster --

DMN August 14, 2010:

“Blockbuster Posts Bigger Loss,

Says Chapter 7 Filing Possible”

  • UPDATE 9/23/10…

  • o BB files for Chapter 11 bankruptcy. Holders

  • of 80% of $630MM of 11.75% senior secured

  • notes supported the filing.

  • o BB claims assets of $1.02B and debt of

  • $1.46B

  • UPDATE 4/26/11…

  • o BB won final amended (90 day extension)

  • approval to sell its assets to Dish Network

  • for $320MM.

  • o Senior secured bondholders (who financed

  • BB operations during bankruptcy) objected

  • because one revision waived a $3MM

  • penalty for the delay.

  • Blockbuster Inc. (BB) had larger than expected 2nd quarter loss, as revenue decreased.

  • Revenue fell 20% to $788MM from $982MM.

  • However, BB’s senior secured debt holders gave extension to Sept 30 on the $42MM interest payment due. It is the second extension.

  • In its quarterly filing to the SEC, BB says Ch 7 bankruptcy (liquidation) is possible, Ch 11 (reorg) is required.

  • In July, BB’s cash balance was $64.3MM, down from $109.9MM in April , and down from $188.7MM in January.

  • BB had net loss of $69MM, or 32 cents / share in 2nd quarter… compared to $37MM loss (21 cents / share) a year ago.


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Types of Financial Ratios

“Total Debt to Total Assets” Ratio =

Total Debt / Total Assets =

$1.46B / $1.02B = 1.43


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“Once Upon a Time…”

-- Blockbuster --

DMN August 14, 2010:

“Blockbuster Posts Bigger Loss,

Says Chapter 7 Filing Possible”

  • UPDATE 9/23/10…

  • o BB files for Chapter 11 bankruptcy. Holders

  • of 80% of $630MM of 11.75% senior secured

  • notes supported the filing.

  • o BB claims assets of $1.02B and debt of

  • $1.46B

  • UPDATE 4/26/11…

  • o BB won final amended (90 day extension)

  • approval to sell its assets to Dish Network

  • for $320MM.

  • o Senior secured bondholders (who financed

  • BB operations during bankruptcy) objected

  • because one revision waived a $3MM

  • penalty for the delay.

  • Blockbuster Inc. (BB) had larger than expected 2nd quarter loss, as revenue decreased.

  • Revenue fell 20% to $788MM from $982MM.

  • However, BB’s senior secured debt holders gave extension to Sept 30 on the $42MM interest payment due. It is the second extension.

  • In its quarterly filing to the SEC, BB says Ch 7 bankruptcy (liquidation) is possible, Ch 11 (reorg) is required.

  • In July, BB’s cash balance was $64.3MM, down from $109.9MM in April , and down from $188.7MM in January.

  • BB had net loss of $69MM, or 32 cents / share in 2nd quarter… compared to $37MM loss (21 cents / share) a year ago.


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Financial Management

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Types

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value


Slide78 l.jpg

Long Range Planning

Economy

Assessment

Past Cash

Flows

Industry / Competition

Assessment

Past BS

Financial

Ratios

Past IS

Other

Internal

Other

External

Sales

Forecasts

Asset

Plan

Other

Resources

Financing

Budgets


Slide79 l.jpg

Long-Term Finl Planning Techniques

Techniques

(1)

(2)

“Cost-

Volume-Profit”

Analysis

“Percentage

of Sales”

Technique

* Using a sales forecast

and firm’s IS & BS to

estimate long-term asset

and financing needs.

* Method to determine

the profitability of

a firm at different

sales levels.

* “Used by managers for

finl planning to estimate

the firm’s operating

profits at different levels

of unit sales.”


Slide80 l.jpg

“Percentage of Sales” Technique

Inputs

Sales

Forecasts

Income

Statement

Info

Balance

Sheet

Info

Asset

Needs

Financing of Needed Assets

Internal

Sources

External

Sources

* Issue Stock?

* Issue Bonds?

* Borrow from bank?

* New sales NIAT

* New current liabilities


Slide81 l.jpg

Business Sources of Funds

Investors (Individuals, institutions, etc.)

(3) Stocks

(equity /

own’p)

(2) Bonds

(debt /

loans)

$

$

Business Funds

External

$

(1) Retained Earnings

Internal

From 1995 – 2005, 88% of securities sold to the public were Bonds.


Slide82 l.jpg

Statement of Cash Flows – p. 307 in text

Internal Funding

“Source”

* Net Income or < Loss >

* Depreciation

* Decrease or < Increase > in Current Asset accts

* Increase or < Decrease > in Current Liability accts

CASH FROM OPERATING ACTIVITIES

* Sale or < Purchase > of Property, Plant,

. Equipment, etc. .

CASH FROM INVESTING ACTIVITIES

* Issuance or < Repurchase > of Stock

* Increase or < Decrease > in Long-Term Debt

* < Dividends > .

CASH FROM FINANCING

NET CHANGE IN CASH

Income Stmt, &

“Current” Accts

Income Stmt, &

“Current” Accts

Must Fund

“Use”

Fixed Assets

Fixed Assets

External Funding

“Source”

Long Term Liabilities

& Owners Equity

Long Term Liabilities

& Owners Equity


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“Percentage of Sales” Technique

Inputs

Sales

Forecasts

Income

Statement

Info

Balance

Sheet

Info

Asset

Needs

Financing of Needed Assets

Internal

Sources

External

Sources

* Issue Stock?

* Issue Bonds?

* Borrow from bank?

* New sales NIAT

* New current liabilities


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“Percentage of Sales” Technique

The Approach:

(1) Take key average IS & BS items, and

express them as a %-age of historical

Sales…

(2) … then, multiply that factor times the

change in Sales to determine the

“starting point” estimate for each new

IS & BS item.

CAUTION: At each stage, adjust for “non-formula” considerations!


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“Percentage of Sales” Technique

-- Analogy --

“Number of People” is

analogous to “Sales”…

You are making Thanksgiving dinner. Here is the amount of food you plan to prepare:

Adjustments:

Turkey:

Green

Beans:

Potatoes:

Cranberry

Sauce:

Pumpkin

Pie:

Last Year,

For 10

People

You Made:

12 lb

2 cans

6 lbs

1 qt

2 pies

This Year,

15 People

( “Starting

Point” ):

18 lb

3 cans

9 lbs

1.5 qts

3 pies

If 5 extra are

Offensive

Linemen:

22 lb

3 cans

12 lbs

2 qts

7 pies

If Vegan

Sorority

Sisters:

12 lb

4 cans

10 lbs

2 qts

2 pies

Calculate amount of each food item per person (analogous to IS & BS items per $$ Sales)…

Turkey = 12 / 10 = 1.2 lbs / pers.

Green

Beans = 2 / 10 = .2 cans / pers.

Potatoes = 6 / 10 = .6 lbs / pers.

Cranberry

Sauce: = 1 / 10 = .1 qt / person

Pumpkin

Pie: = 2 / 10 = .2 pies / person


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“Percentage of Sales” Technique

-- Analogy --

“Number of People” is

analogous to “Sales”…

You are making Thanksgiving dinner. Here is the amount of food you plan to prepare:

Adjustments:

Turkey:

Green

Beans:

Potatoes:

Cranberry

Sauce:

Pumpkin

Pie:

Last Year,

For 10

People

You Made:

12 lb (1.2)

2 cans (.2)

6 lbs (.6)

1 qt (.1)

2 pies (.2)

This Year,

15 People

( “Starting

Point” ):

18 lb

3 cans

9 lbs

1.5 qts

3 pies

If 5 extra are

Offensive

Linemen:

22 lb

3 cans

12 lbs

2 qts

7 pies

If Vegan

Sorority

Sisters:

12 lb

4 cans

10 lbs

2 qts

2 pies


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“Percentage of Sales” Technique

-- “DDD” EXAMPLE --


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“Cost-Volume-Profit” Analysis

Understand

Costs

VC

FC

Unit

Variable

Costs

Total

Fixed

Costs

Sales

Level

Q

EBIT

P = Sales

Price

Determine

EBIT

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC

“Contribution Margin” = amount of each sale

that contributes to the recovery of FC.


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INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

“Cost-Volume-Profit” Analysis

Understand

Costs

VC

FC

Unit

Variable

Costs

Total

Fixed

Costs

Sales

Level

Q

EBIT

P = Sales

Price

Determine

EBIT

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC

“Contribution Margin” = amount of each sale

that contributes to the recovery of FC.


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“Cost-Volume-Profit” Analysis

Understand

Costs

VC

FC

Unit

Variable

Costs

Total

Fixed

Costs

Sales

Level

Q

EBIT

P = Sales

Price

Determine

EBIT

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC

“Contribution Margin” = amount of each sale

that contributes to the recovery of FC.


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INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

“Cost-Volume-Profit” Analysis

Understand

Costs

VC

FC

Unit

Variable

Costs

Total

Fixed

Costs

Sales

Level

Q

EBIT

P = Sales

Price

Determine

EBIT

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC

“Contribution Margin” = amount of each sale

that contributes to the recovery of FC.


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“Cost-Volume-Profit” Analysis

Understand

Costs

VC

FC

Unit

Variable

Costs

Total

Fixed

Costs

Sales

Level

Q

EBIT

P = Sales

Price

Determine

EBIT

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC

“Contribution Margin” = “contribution of each

unit sold that goes toward paying fixed costs”


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“Cost-Volume-Profit” Analysis

-- EXAMPLE --

Assume we want to start selling DDD Kolaches:

* Sell for $2.00 (P)

* $1.50 in Variable Costs (VC)

* $10,000 in Fixed Costs for equipment (FC)

* Sales Forecast: 30,000 per year (Q)

Then, the Forecasted EBIT = (P – VC) (Q) – FC

= ($2 - $1.50) (30,000) - $10,000

= ($.50) (30,000) - $10,000

= $15,000 - $10,000

= $5,000

The Breakeven sales quantity Q (where EBIT = 0):

0 = (P – VC) (Q) - FC

0 = ($2 - $1.50) (Q) - $10,000

0 = ($.50) (Q) - $10,000

Q = $10,000 / $.50

Q = 20,000 units


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CHAPTER 13

Evaluating Business Investments


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Financial Management

  • Forms of Business Own’p

  • Sole Proprietorship

  • Partnership

  • Corporation

Oprns

( Etc. )

Sales

Finance

Acctg

  • Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows

Financial

Statements

Capital

Budgeting

Ratio

Analysis

Long-Term

Planning

  • Techniques

  • “Percentage of

  • Sales”

  • Cost-Volume-Profit

  • Stages

  • Identification *

  • Development *

  • Selection *

  • Implementation

  • Follow-up

  • Types

  • Liquidity

  • Asset Mgmt

  • Finl Leverage

  • Profitability

  • Market Value


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Capital Budgeting

“Capital Budgeting” = “process of identifying,

evaluating, and implementing a firm’s investment

opportunities” … to increase shareholder wealth.

Competitors

External

Environment

Financial

Statements

Firm’s

Mission &

Strategies

Other

Stuff

Capital

Budgeting

Determine,

Fund, And

Implement

Projects


Slide97 l.jpg

Capital Budgeting …

… must identify and invest in projects

that provide positive cash flows to

increase share holder wealth.

Project

Evaluation

Accts for…

( 1 )

( 2 )

( 3 )

( 4 )

Cost

of

Financing

Timing

of Cash

Flows

$ Amount

of Cash

Inflows

$ Amount

of Cash

Outflows


Slide98 l.jpg

Capital Budgeting …

… must identify and invest in projects

that provide positive cash flows to

increase share holder wealth.

Project

Evaluation

Accts for…

“Time Value

Of Money”

( 1 )

( 2 )

( 3 )

( 4 )

Cost

of

Financing

Timing

of Cash

Flows

$ Amount

of Cash

Inflows

$ Amount

of Cash

Outflows

“Rate of

Return”

“Time”

“Amount”


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

IDENTIFICATION = “Finding potential capital investment opportunities and identifying whether a project involves a replacement decision and / or revenue expansion”

Selection

* Assess & Choose

5 Techniques to

determine viability

Implementation

* Implement

Followup

* Track & Review


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability

Implementation

* Implement

Followup

* Track & Review


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

DEVELOPMENT = “Requires estimating relevant cash inflows and outflows”

Selection

* Assess & Choose

5 Techniques to

determine viability

Implementation

* Implement

Followup

* Track & Review


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability

SELECTION = “Applying appropriate capital budgeting techniques to help make a final accept or reject decision”

Implementation

* Implement

Followup

* Track & Review


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

IMPLEMENTATION = “Executing accepted projects”

Selection

* Assess & Choose

5 Techniques to

determine viability

Implementation

* Implement

Followup

* Track & Review


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability

FOLLOWUP = “Tracking, reviewing, analyzing, and / or auditing a project’s result”

Implementation

* Implement

Followup

* Track & Review


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability

Implementation

* Implement

Followup

* Track & Review


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Project “Required Rate of Return”

-- ( aka “Cost of Capital” ) --

REMEMBER: higher risks demand

higher returns …

Uncertainty

of Cash

Flows

Size

Factors

Affecting Req’d

Rate of Return

Timing of

“Point of No

Return”

Flexibility

& Options


Slide107 l.jpg

O

O

O

O

0

1

2

3

I

I

I

1

2

3

0

1

2

3

Years

NPV = PV (All Cash Flows) = PV (Inflows) - PV (Outflows)

= PV (I ) + PV (I ) + PV (I )

- PV (O ) - PV (O ) - PV (O ) - PV (O )

= - PV (O ) + PV (Net ) + PV (Net ) + PV (Net )

So, in the example above (assume required ROR = 10%)…

NPV = - $30k + PV (5,000) + PV (10,000) + PV (25,000)

= - $30k + $4,545 + $8,264 + $18,783 = $1,592

1

2

3

0

1

2

3

1

2

3

0

1

2

3

Project Cash Flows -- EXAMPLE

$ 30k

$ 20k

$ 20k

$ 10k

$ 25k

$ 30k

$ 35k


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Project Cash Flows

-- Impact of “Rate of Return” --

“The higher the I / Y ( ie, the Required

Rate of Return, or Cost of Capital ), the

less valuable future inflows are worth.”

EXTREME EXAMPLE:

FV of $100 in 3 Years:

I / Y = 50%:

$ 150

$ 225

$ 337.50

$ 100

$ 101

$ 102.01

$ 103.03

I / Y = 1%:

$ 100

0

1

2

3

Years

PV of $337.50 3 Years in the future:

I / Y = 50%:

$ 150

$ 225

$ 337.50

$ 100

$ 330.85

$ 334.16

$ 337.50

I / Y = 1%:

$ 327.58

0

1

2

3

Years


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability:

* NPV

* IRR

* MIRR

* PI

* PP

Implementation

* Implement

Followup

* Track & Review


Slide110 l.jpg

5 Methods to Assess Project Viability

(2)

Internal

Rate of

Return (IRR)

(3)

(1)

Net

Present

Value (NPV)

Modified

IRR (MIRR)

Methods

to Assess

Projects

(4)

(5)

Payback

Period

Profitability

Index


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5 Methods to Assess Project Viability


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Project Evaluation Techniques

-- Key Points --

(1)NPV, IRR, MIRR, and PIwill always agree that

a project’s acceptability is a “YES” or “NO”.

(2)NPV is the only technique that quantifies the

$$ amount of shareholder wealth increase.

(3)These methods are most effective when

used with each other, because they each

indicate different things.

(4)The timing of the cash flows is critical to the

project’s acceptability (as is the Required

Rate of Return).

(5)Different “acceptable” rates of return are

required for different risk projects (just like

any investment).


Slide117 l.jpg

Using NPV and PI Together

Reminder:

NPV = PV (Cash Flows) – (Initial Costs)

PI = PV (Cash Flows) / (Initial Costs)

Proj 1:

Proj 2:

PV (Cash

Flows)

$1,100,000

$200,000

Initial

Cost

$1,000,000

$100,000

NPV

$100,000

$100,000

PI

1.1MM /

1.0MM =

1.1

200k /

100k =

2.0


Slide118 l.jpg

Project Evaluation Techniques

-- Key Points --

(1)NPV, IRR, MIRR, and PIwill always agree that

a project’s acceptability is a “YES” or “NO”.

(2)NPV is the only technique that quantifies the

$$ amount of shareholder wealth increase.

(3)These methods are most effective when

used with each other, because they each

indicate different things.

(4)The timing of the cash flows is critical to the

project’s acceptability (as is the Required

Rate of Return).

(5)Different “acceptable” rates of return are

required for different risk projects (just like

any investment).


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“Bedtime Stories”

-- Concepts to Consider --

  • CONCEPTS WE’VE COVERED….

  • Financial Statements

    • Income Statement

    • Balance Sheet

    • Statement of Cash Flows

  • Ratio Analysis

  • Long-Term Planning Techniques

    • Percentage of Sales

    • Cost - Volume - Profit

  • Capital Budgeting Process

    • Identification ( MOGS, SWOT )

    • Development

    • Selection ( NPV, IRR, etc. )


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“Once Upon a Time…”

-- Harley Davidson --

WSJ December 3, 2009:

“Harley Union Makes

Concessions”

Harley Davidson union workers agreed to job cuts of 50%, more work-rule flexibility, and an unusually long labor contract…

… in exchange for Harley investing $90MM in the plant in York, Pa.

The state of Pa. also offered job training, low-interest loans, and $15MM for upgrades.

This paves the way for Harley to cut almost half of the 2,000 non-managerial jobs at the plant.

The contract allows a “casual” worker category, which will earn 30% less than regular workers.

Company wants $120 - $150MM in productivity savings.

Harley had 84% drop in 3rd quarter profits.

The $90MM plant investment means more work will be done there when economy recovers.


Slide121 l.jpg

“Once Upon a Time…”

-- Harley Davidson --

“Cost-Volume-Profit”

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Variable Costs

Fixed Costs

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC


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“Once Upon a Time…”

-- Harley Davidson --

WSJ December 3, 2009:

“Harley Union Makes

Concessions”

Harley Davidson union workers agreed to job cuts of 50%, more work-rule flexibility, and an unusually long labor contract…

… in exchange for Harley investing $90MM in the plant in York, Pa.

The state of Pa. also offered job training, low-interest loans, and $15MM for upgrades.

This paves the way for Harley to cut almost half of the 2,000 non-managerial jobs at the plant.

The contract allows a “casual” worker category, which will earn 30% less than regular workers.

Company wants $120 - $150MM in productivity savings.

Harley had 84% drop in 3rd quarter profits.

The $90MM plant investment means more work will be done there when economy recovers.


Slide123 l.jpg

“Once Upon a Time…”

-- Harley Davidson --

“Cost-Volume-Profit”

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Variable Costs

Fixed Costs

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC


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“Once Upon a Time…”

-- Harley Davidson --

Assessing Project Viability

Net Present Value (NPV) =

PV (Cash Flows) – Initial Cost

With Harley Davidson’s $90MM investment plans…

… What happens to Cash Outflows in the future?

… What happens to the Initial Cost?

… What happens to the Net Present Value?


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“Once Upon a Time…”

-- Harley Davidson --

WSJ December 3, 2009:

“Harley Union Makes

Concessions”

Harley Davidson union workers agreed to job cuts of 50%, more work-rule flexibility, and an unusually long labor contract…

… in exchange for Harley investing $90MM in the plant in York, Pa.

The state of Pa. also offered job training, low-interest loans, and $15MM for upgrades.

This paves the way for Harley to cut almost half of the 2,000 non-managerial jobs at the plant.

The contract allows a “casual” worker category, which will earn 30% less than regular workers.

Company wants $120 - $150MM in productivity savings.

Harley had 84% drop in 3rd quarter profits.

The $90MM plant investment means more work will be done there when economy recovers.


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“Once Upon a Time…”

-- Harley Davidson --

Assessing Project Viability

Net Present Value (NPV) =

PV (Cash Flows) – Initial Cost

With Harley Davidson’s $90MM investment plans…

… What happens to Cash Outflows in the future?

… What happens to the Initial Cost?

… What happens to the Net Present Value?


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“Once Upon a Time…”

-- Harley Davidson --

WSJ December 3, 2009:

“Harley Union Makes

Concessions”

Harley Davidson union workers agreed to job cuts of 50%, more work-rule flexibility, and an unusually long labor contract…

… in exchange for Harley investing $90MM in the plant in York, Pa.

The state of Pa. also offered job training, low-interest loans, and $15MM for upgrades.

This paves the way for Harley to cut almost half of the 2,000 non-managerial jobs at the plant.

The contract allows a “casual” worker category, which will earn 30% less than regular workers.

Company wants $120 - $150MM in productivity savings.

Harley had 84% drop in 3rd quarter profits.

The $90MM plant investment means more work will be done there when economy recovers.


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“Once Upon a Time…”

-- Harley Davidson --

Assessing Project Viability

Net Present Value (NPV) =

PV (Cash Flows) – Initial Cost

With Harley Davidson’s $90MM investment plans…

… What happens to Cash Outflows in the future?

… What happens to the Initial Cost?

… What happens to the Net Present Value?


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“Once Upon a Time…”

-- ConocoPhillips --

WSJ March 25, 2010:

“ConocoPhillips to Rein in Growth”

ConocoPhillips (CP) is changing its “growth” strategy – shifting from “big” to “valuable”.

CP will focus on producing the oil and gas it has.

CP will sell its 9%, 25%, an 10% stakes in various oil companies for $15B.

The $15B will be used to buy back $5B in stock, raise dividends by 10%, and reduce the debt ratio from 31% to 20%.

In the 2000’s, Conoco merged with Phillips, and invested $35B and $8B in other companies, among other investments.

Those investments made CP one of the largest energy companies, but left it with far more debt than its competitors. Then, oil prices dropped.

Analysts question whether CP will get good price for assets – prices are low, and CP’s projects aren’t as attractive as its competitors.


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“Once Upon a Time…”

-- ConocoPhillips --

WSJ March 25, 2010:

“ConocoPhillips to Rein in Growth”

Let’s talk about…

… “MOGS”

… “SWOT”

… “Cleaning up the Balance Sheet”

… “Financial Leverage Ratios”


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“Once Upon a Time…”

-- ConocoPhillips --

WSJ March 25, 2010:

“ConocoPhillips to Rein in Growth”

ConocoPhillips (CP) is changing its “growth” strategy – shifting from “big” to “valuable”.

CP will focus on producing the oil and gas it has.

CP will sell its 9%, 25%, an 10% stakes in various oil companies for $15B.

The $15B will be used to buy back $5B in stock, raise dividends by 10%, and reduce the debt ratio from 31% to 20%.

In the 2000’s, Conoco merged with Phillips, and invested $35B and $8B in other companies, among other investments.

Those investments made CP one of the largest energy companies, but left it with far more debt than its competitors. Then, oil prices dropped.

Analysts question whether CP will get good price for assets – prices are low, and CP’s projects aren’t as attractive as its competitors.


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“Once Upon a Time…”

-- ConocoPhillips --

WSJ March 25, 2010:

“ConocoPhillips to Rein in Growth”

Let’s talk about…

… “MOGS”

… “SWOT”

… “Cleaning up the Balance Sheet”

… “Financial Leverage Ratios”


Slide133 l.jpg

“Once Upon a Time…”

-- ConocoPhillips --

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

“Assets” - “Liabilities” = “Owners Equity”


Slide134 l.jpg

“Once Upon a Time…”

-- ConocoPhillips --

WSJ March 25, 2010:

“ConocoPhillips to Rein in Growth”

ConocoPhillips (CP) is changing its “growth” strategy – shifting from “big” to “valuable”.

CP will focus on producing the oil and gas it has.

CP will sell its 9%, 25%, an 10% stakes in various oil companies for $15B.

The $15B will be used to buy back $5B in stock, raise dividends by 10%, and reduce the debt ratio from 31% to 20%.

In the 2000’s, Conoco merged with Phillips, and invested $35B and $8B in other companies, among other investments.

Those investments made CP one of the largest energy companies, but left it with far more debt than its competitors. Then, oil prices dropped.

Analysts question whether CP will get good price for assets – prices are low, and CP’s projects aren’t as attractive as its competitors.


Slide135 l.jpg

“Once Upon a Time…”

-- ConocoPhillips --

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

$15B

$10B –

dividends

$5B

“Assets” - “Liabilities” = “Owners Equity”


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“Once Upon a Time…”

-- ConocoPhillips --

“Debt Ratio” =

“Liabilities / Assets”

DEBT

ASSETS: LIABILITIES: RATIO:

BEFORE:$ 65B$ 20B .31

AFTER: $ 65B - $ 15B $ 20B - $ 10B .20

= $ 50B = $ 10B


Slide137 l.jpg

“Financial Leverage” -- EXAMPLE

Balance Sheet:

# of $100k

Houses:

Assets:

Liabilities:

“Owner’s Equity”

(ie, “Net Worth”)

1

$100k

$ 0k

$100k

2

$200k

$100k

$100k

10

$1MM

$900k

$100k

“Debt Ratio” = Liab / Assets: 0 .5 .9

o There are costs associated with liabilities

(interest, repayment of amount, etc.).

o “Reducing one’s balance sheet” means

eliminating liabilities (and assets), resulting

in less obligations for the company.


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CHAPTER 14

Estimating Project Cash Flows


Slide139 l.jpg

Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability:

* NPV

* IRR

* MIRR

* PI

* PP

Implementation

* Implement

Followup

* Track & Review


Slide140 l.jpg

Project Stages &

Cash Flow Components

Project

Stages

(1)

(2)

(3)

Initial

Outlay

“Operating

Life”

Termination

* Only if it is a “limited

life” project

* Buildings, equipt, etc.

* Can get “bids” to

determine

* The cost of determining

estimates is a “sunk

cost”


Slide141 l.jpg

Project Cash Flows

Incremental

After-Tax

Cash Flows

Cannibalization

Or

Enhancement

Opportunity

Costs

* Included

( Relevant )

Project

Cash

Flows

* Excluded

( Irrelevant )

(A)

(B)

Financing

Costs

Sunk

Costs

(A)Financing Cost = already accounted for in the

project viability assessment. (Addressed in

Ch 15, which we won’t cover.)

(B)Sunk Cost = “Project related expense not dependent

upon whether or not the project is undertaken.”


Slide142 l.jpg

“Included” Project Cash Flows

(1)

(2)

(3)

Incremental

After-Tax

Cash Flows

Cannibalization

Or

Enhancement

Opportunity

Costs

Includes:

* Revenues

* Expenses

* Depreciation

* Fixed Assets

* Net Working Capital

Project

Cash

Flows

(1)“Incremental…” = ( After-tax cash flows with Project )

- ( “Base Case” of cash flows without Project )

(2)“Cannibalization” = “A project robs cash flows from

the firm’s existing lines of business.”

“Enhancement” = “Increase in the cash flow’s of the

firm’s other products that occur because of a

new project.”

(3)“Opportunity Cost” = “Cost of passing up the next

best alternative.”


Slide143 l.jpg

“Firm” vs. “Project”: Statement

Of Cash Flows

FIRM

Net Income

Depreciation

Current sources

< Current uses >

< Change in gross

fixed Assets >

< Dividends paid >

Net new Bond issues

Net new Stock issues

PROJECT

Net Income

Depreciation

Current sources

< Current uses >

< Funds invested in

project’s fixed

Assets >

NOT APPLICABLE

Cash Flows from OPERATING ACTIVITIES

Cash Flows from INVESTING ACTIVITIES

Cash Flows from FINANCING ACTIVITIES


Slide144 l.jpg

Cash Flows: “Firm’s” vs. “Project’s”

Which Cash Flows are included?

.

ACTIVITY Firm Project.

* OPERATING ACTIVITIES Y Y

* INVESTING ACTIVITIES Y Y

* FINANCING ACTIVITIES Y N


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“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


Slide146 l.jpg

Income Statement - p. 302 in text

“Revenues & Expenses”

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Income to

Bond holders

Belongs to

Stock holders,

or Owners

One of 3 things can be done with the Earnings:

(1) Pay it to Stock holders as income = “Dividend”

(2) Retain it, and reinvest it in the company

(3) Retain it, and hold it as cash or securities


Slide147 l.jpg

“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


Slide148 l.jpg

Balance Sheet – p. 304 in text

* Cash & Marketable Securities

* Accounts Receivable

* Inventories

* Other Current Assets

CURRENT ASSETS

FIXED ASSETS (ie, Plant, Equipt, etc.)

TOTAL ASSETS

* Accounts Payable

* Notes Payable

* Other Current Liabilities

CURRENT LIABILITIES

LONG-TERM LIABILITIES (ie, LT Debt)

TOTAL LIABILITIES

* Preferred Equity

* Common Equity

* Retained Earnings

TOTAL OWNERS EQUITY

15MM shares

15MM shares

“Assets” - “Liabilities” = “Owners Equity”


Slide149 l.jpg

“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


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Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability:

* NPV

* IRR

* MIRR

* PI

* PP

Implementation

* Implement

Followup

* Track & Review


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“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


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“Dividend Payout Ratio” = % of earnings that is paid out

as dividends = =

( Dividends / Share ) Dividends

( Earnings / Share ) Earnings

Policies for Dividend Amounts

Dividend

Amount

(1)

(2)

(3)

Target

Dividend Ratio

Policy

Residual

Dividend

Policy

Special

Dividend

Policy

B.O.D. gradually

adjusts div. payout

ratio to approach

target.

Div. varies based

on excess funds.

( “Pay out what we

have left.” )

Pays occasional

higher dividend

when the earnings

are high.

“Dividend Yield” =

Dividend / Share

Stock Price

Not the same as…


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“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


Slide154 l.jpg

Capital Budgeting Process Phases

MOGS

SWOT

“Mission, Objectives,

Goals, Strategies”

“Strengths, Weaknesses,

Opportunities, Threats”

Identification

* Project Opportunities

Development

* Estimate Cash Flows

Selection

* Assess & Choose

5 Techniques to

determine viability:

* NPV

* IRR

* MIRR

* PI

* PP

Implementation

* Implement

Followup

* Track & Review


Slide155 l.jpg

“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


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“Once Upon a Time…”

-- Starbucks --

“Cost-Volume-Profit”

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Variable Costs

Fixed Costs

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC


Slide157 l.jpg

“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


Slide158 l.jpg

“Once Upon a Time…”

-- Starbucks --

“Cost-Volume-Profit”

INCOME STATEMENT:

Revenues

< Cost of Goods Sold >

Gross Profit

< Selling, General, & Administrative Expenses >

< Depreciation >

Operating Income (or EBIT)

< Interest >

Net Income Before Taxes (NIBT)

< Taxes >

Net Profit, Earnings, NIAT

Revenues

EBIT = Revenues – Costs

= Revenues – Variable Costs – Fixed Costs

= P (Q) – VC (Q) – FC

= (P – VC) (Q) – FC


Slide159 l.jpg

“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


Slide160 l.jpg

Statement of Cash Flows – p. 307 in text

* Net Income or < Loss >

* Depreciation

* Decrease or < Increase > in Current Asset accts

* Increase or < Decrease > in Current Liability accts

CASH FROM OPERATING ACTIVITIES

* Sale or < Purchase > of Property, Plant,

. Equipment, etc. .

CASH FROM INVESTING ACTIVITIES

* Issuance or < Repurchase > of Stock

* Increase or < Decrease > in Long-Term Debt

* < Dividends > .

CASH FROM FINANCING

NET CHANGE IN CASH

Income Stmt, &

“Current” Accts

Fixed Assets

Long Term Liabilities

& Owners Equity


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“Once Upon a Time…”

-- Starbucks --

Assessing Project Viability

Net Present Value (NPV) =

PV (Cash Flows) – Initial Cost

What happens to the Net Present Value?


Slide162 l.jpg

“Once Upon a Time…”

-- Starbucks --

WSJ Various articles in 1st Half, 2010…

Starbucks (SB) announced first-ever dividend, equal to 35 – 40% of net income.

Also will buy back 15MM shares with about 45% of this year’s expected earnings.

McDonald’s and Dunkin’ Donuts have eroded SB’s specialty coffee market share.

Dividend yield is expected to be about 2.5%.

SB has 4% of US and 1% of global coffee market.

New growth model: get more coffee to the customer regardless of form, venue, or brand.

During recession, SB shut 100’s of stores, laid off 1000’s of people, and cut $600MM in costs.

SB will focus on growth of Seattle’s Best brand it bought in 2003, selling it in Subway and BK – distribution points will go from 3,000 to 30,000.

Sales of its instant-coffee packet Via are strong.

SB expects $1B in free cash flow. New growth model requires less cash to expand (“asset light”).

SB share bought for $13 in 1992 is worth $820 now.


Slide163 l.jpg

“Once Upon a Time…”

-- Starbucks --

  • What annual rate of return did Starbucks stock provide from 1992 to 2010?

  • Let’s use the “The Rule of 72”…

  • Stock price went from $13 to $820 in 18 years. So it doubled…

  • $13 to $26 … (1 time)

  • … to $52 … (2 times)

  • … to $104 … (3 times)

  • … to $208 … (4 times)

  • … to $416 … (5 times)

  • … to $832 (6 times)

  • If it doubled 6 times in 18 years, that

  • means it doubled once every 3 years.

  • 72 divided by 3 is 24.

  • So, the stock averaged 24% annual

  • return from 1992 to 2010.


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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Sample Exam 4 Questions


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