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Chapter I & IITutorial
Introduction
Financial statements
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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
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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?
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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
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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
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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?
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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
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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?
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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
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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?
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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
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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?
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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
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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.
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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.
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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.
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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.
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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?
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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%
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Financial Statements
• Balance sheet
• Income statement
• Cash flow
• Statement of retained earnings
• Statement of stockholders equity
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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
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Income Statement
• Revenue– Sales revenue
– Interest income
– Irregular income
• Expense– Cost of goods sold
– Operating expenses
– Depreciation expense
– Interest expense
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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
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Problem 2 - 1
• See book
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Problem 2 - 2
• See book