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Financial Ratios for Pre-Business Plan ImplementationFinancial Ratios for Business Plan Implementation Phase1Financial RatiosBusiness Plan Implementation PhasePre-Business Plan ImplementationPayback periodNet Present Value (NPV)Internal Rate of Return (IRR)ProfitabilityActivityOperating CycleFinancial LeverageLiquidity2Ratios for Pre-Business Plan Implementation3The payback period is the amount of time required for the firm to recover its initial investment. If the projects payback period is less than the maximum acceptable payback period, accept the project. If the projects payback period is greater than the maximum acceptable payback period, reject the project.Management determines maximum acceptable payback period.Payback period3

Initial Outlay-$250Year 1 inflow$35Year 2 inflow$80Year 3 inflow$130Year 4 inflow$160Year 5 inflow$175

Initial Outlay-$50Year 1 inflow$18Year 2 inflow$22Year 3 inflow$25Year 4 inflow$30Year 5 inflow$32Advantages of payback method: Computational simplicity Easy to understand Focus on cash flowDisadvantages of payback method: Does not account properly for time value of money Does not account properly for risk Cutoff period is arbitrary Does not lead to value-maximizing decisionsPros and Cons of the Payback MethodNet Present Value (NPV)Net Present Value (NPV): Net Present Value is found by subtracting the present value of the after-tax outflows from the present value of the after-tax inflows.

Net Present Value (NPV)Decision CriteriaIf NPV > 0, accept the projectIf NPV < 0, reject the projectIf NPV = 0, technically indifferentNet Present Value (NPV): Net Present Value is found by subtracting the present value of the after-tax outflows from the present value of the after-tax inflows.

Using the Bennett Company data below, assume the firm has a 10% cost of capital.Based on the given cash flows and cost of capital (required return), the NPV can be calculated as follows:

Key benefits of using NPV as decision rule: Focuses on cash flows, not accounting earnings Makes appropriate adjustment for time value of money Can properly account for risk differences between projectsThough best measure, NPV has some drawbacks: Lacks the intuitive appeal of payback, and Doesnt capture managerial flexibility (option value) well.NPV is the gold standard of investment decision rules.Pros and Cons of NPV12Internal Rate of Return (IRR)The Internal Rate of Return (IRR) is the discount rate that will equate the present value of the outflows with the present value of the inflows.The IRR is the projects intrinsic rate of return.

14Decision CriteriaIf IRR > k, accept the projectIf IRR < k, reject the projectIf IRR = k, technically indifferentThe Internal Rate of Return (IRR) is the discount rate that will equate the present value of the outflows with the present value of the inflows.The IRR is the projects intrinsic rate of return. 15

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Financial RatiosBusiness Plan Implementation PhasePre-Business Plan ImplementationPayback periodNet Present Value (NPV)Internal Rate of Return (IRR)ProfitabilityActivityOperating CycleFinancial LeverageLiquidity18Ratios for Business Plan Implementation PhaseMeasuring ProfitabilityGross profit income =Gross incomeSalesOperating profit margin =Operating incomeSalesNet profit margin =Net incomeSales19Ratios for Business Plan Implementation PhaseActivityInventory turn-over =Cost of good soldInventoryA/R turnover =Sales on creditAccounts receivableTotal asset turnover =SalesTotal assetsFixed asset turnover =SalesFixed assets20Ratios for Business Plan Implementation PhaseOperating CycleNumber of days of inventory =InventoryAve. days cost of goods sold=InventoryCost of goods sold / 36521Ratios for Business Plan Implementation PhaseOperating CycleNumber of days of receivables =Accounts receivableAve. days sales on credit=Accounts receivableSales on credit / 36522Ratios for Business Plan Implementation PhaseOperating CycleNumber of days of payables =Accounts payableAve. days puchases=Accounts payablePurchases / 36523Ratios for Business Plan Implementation PhaseOperating CycleOperating cycle =Number of days of inventory+Number of days of receivables24Ratios for Business Plan Implementation PhaseOperating CycleNet Operating cycle =Number of days of inventory+Number of days of receivables-Number of days of purchases25Ratios for Business Plan Implementation PhaseFinancial LeverageTotal debt to assets ratio =Total debtTotal assetsLong-term debt to assets ratio =Long-term debtTotal assetsTotal debt to equity ratio =Total debtTotal shareholders equity26Ratios for Business Plan Implementation PhaseMeasuring LiquidityCurrent ratio =Current assetsCurrent liablitiesQuick ratio =Current assets - InventoryCurrent liabilities27