What Nonsense are We T eaching Now ! Dad Will NoT Pay?

1. What Nonsense are We Teaching Now!Dad Will NoT Pay? Ted Mitchell

2. In-Class Exercise • The following statements are often made by business people: • Indicate the degree to which they make sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

3. Statement #1 • Our customer retention rate is higher this year than last year; however, we are keeping fewer customers, than ever before. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

4. Statement #2 • The turnover rate in our sales force has improved from last year. However, we are losing more salesmen than ever before. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

5. Statement #3 • Our profit margins are a measure of our business efficiency. Over the last two months our return on sales decreased; fortunately our profits increased. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

6. Statement #4 • The return on investment was 10% last period and the profit was $200. The efficiency the firm grew last period and the return on investment increased to 20% but the profit dropped to $100. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

7. Statement #5 • Our market share, S, increased over the last year. However our sales revenue declined. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

8. Statement #6 • I have lowered my price and I am making more money. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

9. Statement #7 • I have increased the amount of advertising the firm is doing and I am making less money. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

10. Statement #8 • The bank increased the interest rate on my account from 4% to 5%. However, I am making less interest than I did before. • Indicate the degree to which the above makes sense to you. • 1 total nonsense • 2 very little sense • 3 some sense • 4 perfect sense

11. Why do the statements sound strange?

12. Statement #8 • The bank increased the interest rate on my account from 4% to 5%. However, I am making less interest than I did before. • The above is probably less strange to your ear because you know what happened! • You know that you took money out of the account and there was less in the account to make interest on. • You know that 4% interest on $500 gives you $20You know that 5% interest of $200 gives you $10

13. Your Dad promised you that he would match your gains in investments if you invested your money more wisely. • You invested your money more wisely by putting it into an account which gave you 5% rather 4% interest. • Your Dad will NOT give you any money because you only made $10 this period instead of the $20 you normally make in interest.

14. You know that 4% interest on $500 gave you a $20 payment last periodYou know that 5% interest of $200 gave you a$10 payment this period • You had to spend the extra $300 on books this year! Its not your fault!! • There is a -$10 difference in the two payments • How much of the $10 difference in payments is due to the change in interest rate and how much is due to the change in the size of the account?

15. Should He give Money? • Yes! He should give you money because you did improve your investment • How much should he give you? • Your Dad should give $2 for the improvement in your investment strategy!

22. How do we calculate the impact of each individual change on the overall change? • I∆A = the minimum interest rate x the change in the size of the account • I∆A = (4% or 5%) x ($200-$500) • I∆A = 4% x -$300 = -$12

23. How do we calculate the impact of each change on the overall change? • I∆R = the minimum account x the change in the interest rate • I∆R = ($200 or $500) x (5%-$4%) • I∆R = $200 x 1% = $2

24. The net of the two impacts has to equal the total change • Impact of the change in the account size plus the change in the interest rate has to equal the change in the interest payment • I∆A + I∆R = ∆Z-$12 +$2 = -$10

26. How to see this graphically

27. Interest rate Interest payment = 4% x $500 = $20 4% Account size $500

28. Interest payment = 5% x $200 = $10 Interest rate Interest payment = 4% x $500 = $20 5% 4% $200 Account size $500

29. I∆R = min(A1,A2) x ∆R I∆R = $200 x 1% = $2 Interest rate I∆A = min(R1,R2) x ∆A I∆A = 4% x -$300 = -$12 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

30. Why minimums? Why not maximums? I∆R = min(A1,A2) x ∆R I∆R = $200 x 1% = $2 Interest rate I∆A = min(R1,R2) x ∆A I∆A = 4% x -$300 = -$12 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

31. I get 500 x 1% =$5 Not $2 Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

32. I get 5% x -$300= -$15 Not -$12 Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

33. $3 here that does not exist! Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

34. $3 here that does not exist! Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

35. We use the minimums so we know what the true individual impact of each change is! $3 here that does not exist! Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

36. What happens when both the things change in the same direction! $3 here that does not exist! Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

37. Now the $3 here does exist! Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

38. The $3 is here as a joint impact! An Interaction term A synergy term Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

39. It is the result of both changes together! Interest rate 5% ∆R = 1% 4% $200 Account size $500 ∆A = -$300

40. The Total Equation • ∆Z = I∆A + I∆R + J • Change in the payment = the impact of the change in the size of the Account plus the impact of the change in the Interest Rate plus the Joint Impact (if any) of the two changes

41. If the account had increased from $200 to $500 • And the interest rate fro 4% to 5% • The the problem changes

43. The total new payment is $17 Interest rate 5% Impact of ∆R =$2 J =$3 ∆R = 1% 4% Payment of $8 Impact of the ∆A = $12 $200 Account size $500 ∆A = -$300

44. Lots of Questions and Applications yet to answer!