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Chapter I & II

Tutorial
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 treasurers staff contends that the
firm is running low on cash and might
have trouble paying its bills.
The controllers 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 firms net profit
Using cash accounting show the firms 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 firms 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 fulltime 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 firms tax liability.


How much are after tax earnings?
What was the firms average tax rate?
What was the firms 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
Stockholders 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 firms 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