Chapter I & II Tutorial

Chapter I & IITutorial Introduction Financial statements

Role and Environment of Managerial Finance Finance and its major areas and opportunities Managerial finance function and its relationship to economics and accounting Primary activities of financial manager Goal of the firm, corporate governance, role of ethics and agency issue Financial institutions and markets Business taxes and their importance in financial decisions

Critical Thinking Starbucks case: foreign expansion Possible issues for CFO: Currency risk What additional concerns might a CFO face when a company expands into international markets?

Exercise 1 - 2 You are a treasurer at AIMCO, who develops technology for video conferencing Manager of a division asks you to authorize a capital expenditure of $10,000 The funds are for a project on which $2,5 million had been spent over the past years He admits though that the technology concept developed has been surpassed Use marginal cost-benefit analysis

Example 1 - 2 Solution Sunk costs – ignored by marginal benefit analysis = $2,5m are irrelevant Will the $10,000 additional investment generate a revenue exceeding $10,000? Compare to other possible projects Competitors, industry, new technology

Exercise 1 - 3 The end of the year party The treasurer’s staff contends that the firm is running low on cash and might have trouble paying its bills. The controller’s staff disagrees as the firm continues to be very profitable. Can both sides be right?

Exercise 1 - 3 Solution Cash Flow vs. Accrued Profits Expenses have shorter due date than expected revenues Short term financing Cash crunch, company experience, employee morale

Exercise 1 - 4 Some branches of Donut Shop, Inc., have dropped the practice of allowing employees to accept tips. You notice that the lines are longer and more mistakes are being made in your order. Why tips can be viewed as stock options and incorrect orders could represent a case of agency cost? If tips are gone, how can they reduce these agency costs?

Exercise 1 - 4 Solution Agency costs - incurred by stockholders to ensure against dishonest acts and to give incentives to management Banning tips reduced performance Profit sharing plan Unnecessary backlash

Problem 1 - 2 Marginal cost benefit analysis Benefits from new robotics $560,000 Benefits from old robotics $400,000 Cost of new equipment $220,000 Sale of old equipment $70,000 Calculate marginal benefits, costs, net benefit. What do you recommend that the company do? Why? What other factors should you consider?

Problem 1 - 2 Solution Marginal benefits = 560,000 - 400,000 = 160,000 Marginal cost = 220,000 - 70,000 = 150,000 Net benefits = MB - MC = 10,000 Net benefit positive = recommend replacement Consider timing, cash flow and risk

Problem 1 - 3 Accrual income versus cash flow Value of books shipped $760,000 Collected in cash $690,000 Cost of books $300,000 Using accrual accounting show the firm’s net profit Using cash accounting show the firm’s net cash flow Which of the statements is more useful to the financial manager and why?

Problem 1 - 3 Solution Net profit = Sales - Cost of goods sold = 760,000 - 300,000 = 460,000 Net cash flow = Cash receipts - Cost of goods sold = 690,000 - 300,000 = 390,000 Cash flow statement is more useful to financial manager

Problem 1 - 4 Identifying agency problems, costs and resolutions The front desk receptionist routinely takes an extra 20 minutes of lunch to run personal errands. Division managers are padding cost estimates so as to show short-term efficiency gains when the costs come in lower than the estimates.

Problem 1 - 4 Solution Employee compensated for unproductive time Installing time clock Opportunity costs. Money budgeted to cover inflated costs is not available for other projects. Base reward system on how close the estimates are.

Problem 1 - 4 cont… The firm’s CEO has secret talks with a competitor about the possibility of a merger in which (s)he would become a CEO of the combined firm. A branch manager lays off experienced full-time employees and staffs customer service positions with part-time workers to lower costs and raise profit. His bonus is based on profitability.

Problem 1 - 4 Solution cont… The CEO may negotiate a deal favoring the buyer. Open the firm up for purchase bids. Part time workers are generally not as productive as full-time employees. Implementing stock incentive plan.

Problem 1 - 5 • Corporate Taxes • EBIT = $92,500 • $75,000 to $100,000 • Base tax 13,750 + 34% * amount over $75,000 • Calculate firm’s tax liability. • How much are after tax earnings? • What was the firm’s average tax rate? • What was the firm’s marginal tax rate?

Problem 1 - 5 Solution • Total taxes due • 13,750+[0.34*(92,500-75,000)] • 13,750+5,950 = 19,700 • After tax earnings: 92,500 - 19,700 = 72,800 • Average tax rate: 19,700 / 92,500 = 21,3% • Marginal tax rate: 34%

Financial Statements Balance sheet Income statement Cash flow Statement of retained earnings Statement of stockholders equity

Balance Sheet • Assets • Cash • Accounts receivable • Inventories • Land and buildings • Machinery and equipment • Other • Accumulated depreciation • Liabilities • Accounts payable • Accruals • Long-term debt • Stockholder’s equity • Retained earnings

Income Statement • Revenue • Sales revenue • Interest income • Irregular income • Expense • Cost of goods sold • Operating expenses • Depreciation expense • Interest expense

Cash Flow • Analyses the firm’s ability to generate cash and cash equivalents • Direct and Indirect method to calculate • Statement of CF shows: • Where did the cash come from? • What was it used for? • What was the change in the cash balance? • Operating, Investing and Financing activities • Sources vs. Usage of funds

Problem 2 - 1 See book

Problem 2 - 2 See book

Chapter I & II Tutorial