Completion of Accounting Chapter Summaries

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ACC 201: Essentials of Accounting

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Chapter 6: How Do You Deal with Demand Uncertainty?

Net Cash Flow (NCF) is a good indicator of profitability but are all input factors easy to estimate?

Not at all! Cost estimates, for the most part, are fairly reliable.

On the revenue side, price and sales growth are also fairly reliable.

But the steady state Demand is a highly uncertain number.

What problems does an uncertain demand cause?

Whether the predicted NCF is high or low depends critically on how optimistic or pessimistic the decision maker has been in his steady state demand estimation.

Don’t be too pessimistic or vise versa.

What is the impact on NCF, if first year demand is half what you predicted? ___________________ ___ .

Given its impact on NCF, should firms conduct market research to estimate demand?

Although market research is a good idea, it too has problems.

First, market research can be significantly costly.

Second, it can only reduce (not eliminate) uncertainty, as such, the problem still remains.

How then should a manager deal with an uncertain demand?

Calculate the Breakeven Point; the point of demand (or revenues) at which NCF is Zero.

Break even point is main took for dealing with uncertain demand.

Net Cash Flow - Demand Line

y = 6.75x -239500-300,000-200,000-100,0000100,000200,000300,000400,000500,000010,00020,00030,00040,00050,00060,00070,00080,00090,000100,000Net Cash Flow (NCF) -Demand

What is a Unit Contribution Margin (UCM)?

Unit Contribution Margin (UCM) is the additional operational cash flow that each additional unit brings.

UCM is the Slope of the Net Cash Flow – Demand Graph.

UVC is the additional cash inflow per unit

UCM = Price – UVC

UVC is the additional cash outflow per unit

What factors increase UCM?

UCM will increase if the price per unit increases . Slope will become steeper

UCM will increase if the unit variable cost decreases .

When does Unit Variable Costs (UVC) decrease?

Often, the unit variable cost is lower for firms willing to incur a higher fixed cost.

Ex: Investing in a high-end assembly line will be more energy and material efficient.

Operating Leverage is a measure that captures this trade-off between variable and fixed costs.

What is Operating Leverage (OL)?

Operating Leverage is a measure of the fixed cost relative to the total costs,

It takes a value between 0 (no fixed costs) and 1 (all fixed costs).

OL = Fixed Costs

Fixed Costs + Variable Costs

What is the algebraic expression of the NCF – Demand line?

NCF = - (Start-up Costs + Fixed Costs) + UCM x Demand = 0

How do you calculate the Break-even Point?

BEP = Start-up Costs + Fixed Costs

UCM

What is the Margin of Safety (MS)?

MS = Predicted Demand – Breakeven Demand

What is Percentage Margin of Safety (MS)?

Percentage MS (PMS) = Predicted Demand – Breakeven Demand

Predicted Demand

PMS measures the extent to which demand can drop before Net Cash Flow becomes Negative .

Accordingly, firms like to see a high PMS because a low PMS is an indication of a risky business in that a small drop in percentage sales can make business.

What is the Degree of Operating Leverage (DOL)?

DOL = Percentage Change in Net Cash Flow

Percentage Change in Demand

Percentage Change in Net Cash Flow = DOL * Percentage Change in Demand

Interestingly, DOL = 1/PMS

In other words, PMS is an Inverse measure of risk.

More than fifty percent it is less risky

What problems do multiple products cause for Breakeven Analysis?

When there is uncertainty of demand of multiple products, there are infinite ways to breakeven!

This complicates the concepts of Margin of Safety and Degree of Operating Leverage.

How do firms get around this problem?

Often, the sales-mix between products do not change considerably even when demand levels change.

As such, firms assume a constant sales-mix which greatly simplifies the Breakeven Analysis.

Uncertain Revenues replace Uncertain Demand.

CMR (Contribution Margin Ratio) replaces UCM

NCF – Revenue Line replaces NCF – Demand Line for example: for every dollar that comes in, 56 cents stays in the business (tee shirts)

CMR is the slope of the NCF – Revenue Line

NCF = - (Start-up Costs + Fixed Costs) + CMR x Revenues

Net Cash Flow - Revenue Line

BEP = Start-up Costs + Fixed Costs

CMR

MS = Predicted Revenue – Breakeven Revenue

Percentage MS (PMS) = Predicted Revenue – Breakeven Revenue

Predicted Revenue

DOL = Percentage Change in Net Cash Flow

Percentage Change in Revenues

Percentage Change in Net Cash Flow = DOL * Percentage Change in Revenues

DOL = 1/PMS

_1517589349.xls

Chart1

1316000
1184400
1052800
921200
789600
658000
526400
394800
263200
131600
0

Net Casfflow - Revenues

506625

432012.5

357400

282787.5

208175

133562.5

58950

-15662.5

-90275

-164887.5

-239500

CH2

CH 2: Product or Service
Name of primary product or service	Game specific T shirts
Target market	Participants of SU Dome events
Their need that is served	Need to cheer for SU teams
Your assets that are utilized	Familiarity with dome events; international connections; EEE major
Partner's assets that are utilized	Student manager for SU Basketball; Marketing major

CH3

CH 3: Estimating Revenues
CH 3A: Marketing Plan
Product	T-shirt in a see-through plastic wrapping
Price	$10 per T shirt
Place	Sold on-line, in-stores and at busy spots on game days.
Promotion	Post Standard and TV / Daily Orange advertisements
CH 3B: Estimating Revenues
Target population	100,000
Price per unit	$10.00
Number of steady state consumers per year	5,000
Average yearly consumption per customer	4
Steady state demand per year	20,000
Year	Y1	Y2	Y3	Y4	Y5	Y:1-5
Demand Growth	80%	90%	100%	100%	100%	470%
Demand of P1	16,000	18,000	20,000	20,000	20,000	94,000
Price of P1	10.00	10.00	10.00	10.00	10.00	10.00
Revenues	160,000	180,000	200,000	200,000	200,000	$940,000
CH 3C: Demand Curve
Alternate price per unit	$12.00
Corresponding steady state demand per year	12,000
Price sensitivty	-4,000.00
Price elasticity	-2.00
Price	Demand
0.00	60,000
2.50	50,000
5.00	40,000
7.50	30,000
10.00	20,000
12.50	10,000
15.00	0
17.50	-10,000
20.00	-20,000
22.50	-30,000
25.00	-40,000
27.50	-50,000
30.00	-60,000
CH 3D: Maximizing Revenues over Price
Price	Revenues
$1,057,500	-4,000
0.00	0
2.50	587,500
5.00	940,000
7.50	1,057,500
10.00	940,000
12.50	587,500
15.00	0
17.50	-822,500
20.00	-1,880,000
22.50	-3,172,500
25.00	-4,700,000
27.50	-6,462,500
30.00	-8,460,000
Price per unit	$7.50
Steady State Demand per Year	30,000
Price sensitivty of demand	-4,000.00
Price elasticity of demand	-1.00
Year	Y1	Y2	Y3	Y4	Y5	Y:1-5
Demand Growth	80%	90%	100%	100%	100%
Demand of P1	24,000	27,000	30,000	30,000	30,000	141,000
Price of P1	7.50	7.50	7.50	7.50	7.50	7.50
Revenues	180,000	202,500	225,000	225,000	225,000	$1,057,500

This is the revenue you generate from one unit of your product or service.

This is the number of times you will be able to collect the price stated in cell B23 each year.

Typically, it takes about two years before demand reaches steady state.

Alex P Thevaranjan: State the items you like to bundle together in your primary product or service.

Alex P Thevaranjan: This is the cash inflow from one unit of your product or service. This may come directly from may come directly from the consumers or indirectly from advertisers and donors.

Alex P Thevaranjan: This is where or how the exchange of money for goods will take place.

Alex P Thevaranjan: This is how you plan to communicate your first 3 Ps to your target consumers.

Alex P Thevaranjan: This is the number of individuals in your target market, all of them will not become consumers.

CH3

Revenues - Price Curve

CH4

Demand - Price Line

CH5

CH 4: Managing Costs
CH 4A: Production Plan - Flow Chart
Shipped to USA once a semester		Plain T shirts made in Mexico every semester
Game specific logos printed		Printing machine purchased during start-up phase
Packaged in a plastic bag		Employees needed
Inventories in main shop at Marshall Square Mall		Owners take turns to manage stores
Sold through online orders		Agreement with credit card companies
Sold through Marshall store		Furniture and Office appliances purchased during start-up phase
Sold on the game day		10 part-time employees hired during event days
CH 4B: Estimating Costs and Net Cash Flow
	Repeating Operational Costs		One-time Start-up Costs
Name of Cost	Variable Cost per unit	Fixed Cost per year	Start-up Expense	LT Asset
T shirt	4.00
Packaging materials	0.50
Trip to Mexico		1,000	2,000
Shipping costs		2,000
Logo printing machine				30,000
Employee (sales) salary	0.50	12,800
Employee (packaging)	0.25
Initial Promotion			5,000
Routine Promotion		1,000
Legal costs			1,000
Insurance costs		2,000
Store furniture				2,000
Store rent		18,000
ISP fee		600
Accounting fee		500
Total	$5.25	$37,900	$8,000	$32,000
Cash Flows during	Y1	Y2	Y3	Y4	Y5	Y:1-5
Cash collection from Customers	$180,000	$202,500	$225,000	$225,000	$225,000	$1,057,500
Cash payment for variable costs	126,000	141,750	157,500	157,500	157,500	740,250
Cash payments for fixed costs	37,900	37,900	37,900	37,900	37,900	189,500
Cash Inflow from Operations	$16,100	$22,850	$29,600	$29,600	$29,600	127,750
Cash payment for start-up expenses	8,000					8,000
Cash investment in LT assets	32,000					32,000
Cash Out flow for Start-up Costs	-$40,000					-$40,000
Net Cash Flow	-23,900	22,850	29,600	29,600	29,600	87,750
CH 4C: Maximizing Net Cash Flow over Price
Price	Net Cash Flow	Revenues
217,000	-$4,000.00	`
0.00	-1,710,000	0
2.50	-875,750	587,500
5.00	-276,500	940,000
7.50	87,750	1,057,500
10.00	217,000	940,000
12.50	111,250	587,500
15.00	-229,500	0
17.50	-805,250	-822,500
20.00	-1,616,000	-1,880,000
22.50	-2,661,750	-3,172,500
25.00	-3,942,500	-4,700,000
27.50	-5,458,250	-6,462,500
30.00	-7,209,000	-8,460,000
Price per unit	$10.00
Steady State Demand per Year	20,000
Price sensitivity	-4,000
Price elasticity	-2.00
Year	Y1	Y2	Y3	Y4	Y5	Y:1-5
Demand Growth	80%	90%	100%	100%	100%
Demand of P1	16,000	18,000	20,000	20,000	20,000	94,000
Price of P1	10.00	10.00	10.00	10.00	10.00	10.00
Revenues	160,000	180,000	200,000	200,000	200,000	$940,000
Cash Flows during	Y1	Y2	Y3	Y4	Y5	Y:1-5
Cash collection from Customers	$160,000	$180,000	$200,000	$200,000	$200,000	$940,000
Cash payment for variable costs	84,000	94,500	105,000	105,000	105,000	493,500
Cash payments for fixed costs	37,900	37,900	37,900	37,900	37,900	189,500
Cash Inflow from Operations	$38,100	$47,600	$57,100	$57,100	$57,100	257,000
Cash payment for start-up expenses	8,000					8,000
Cash investment in LT assets	32,000					32,000
Cash Out flow for Start-up Costs	-$40,000					-$40,000
Net Cash Flow	-1,900	47,600	57,100	57,100	57,100	217,000

For some variable costs, you might have to think and work hard to estimate the VC per unit. It should never be higher than the price per unit.

Note these fixed costs must be stated per year. As such, you might have to do the necessary conversion to turn a daily, weekly or monthly cost into a yearly cost.

These are costs you incur at the beginning to invest in something which can be resold.

These are also costs that you incur in the beginning for something which cannot be resold.

CH5

Net Cash Flow

Revenues

Revenues / Net Cash Flow - Price

CH6

CH 5: Strategizing to Enhance Profitability
Initial Net Cash Flow	$217,000
Ater Strategic Positioning	$395,000
After adding Secondary Products and Services	$506,625
CH 5A: Strategic Positioning	Product Differentiation				Operational Efficiency
Strategy under chosen positioning	Invest in a higher quality logo printing machine ($40,000) and increase price to $12
CH 5B: Strategic Product-line Expansion
Product Number	Name of Product or Service
P1 =	Game specific T shirts
P2 =	Game specific caps
P3 =
Products / Services	P1	P2	P3
Steady state demand per year	20,000	5,000
Price per unit	$12.00	8.00
Year	Y1	Y2	Y3	Y4	Y5	Y:1-5
Demand Growth	80%	90%	100%	100%	100%
Demand of P1	16,000	18,000	20,000	20,000	20,000	94,000
Price of P1	12.00	12.00	12.00	12.00	12.00	12.00
Demand of P2	4,000	4,500	5,000	5,000	5,000	23,500
Price of P2	8.00	8.00	8.00	8.00	8.00	8.00
Demand of P3	0	0	0	0	0	0
Price of P3	0.00	0.00	0.00	0.00	0.00	0.00
Revenues	224,000	252,000	280,000	280,000	280,000	$1,316,000
	Operational Cost					Start-up Cost
Name of Cost	Unit Variable Cost			Fixed Cost		Start-up Expense		LT Asset
	P1	P2	P3	P1	+ P2 + P3	P1	+ P2 + P3	P1	+ P2 + P3
T shirt	4.00			0		0		0
Packaging materials	0.50			0		0		0
Trip to Mexico	0.00			1,000		2,000		0
Shipping costs	0.00			2,000		0		0
Logo printing machine	0.00			0		0		40,000
Employee (sales) salary	0.50	0.25		12,800		0		0
Employee (packaging)	0.25			0		0		0
Initial Promotion	0.00			0		5,000		0
Routine Promotion	0.00			1,000		0		0
Legal costs	0.00			0		1,000		0
Insurance costs	0.00			2,000		0		0
Store furniture	0.00			0		0		2,000
Store rent	0.00			18,000		0		0
ISP fee	0.00			600		0		0
Accounting fee	0.00			500		0		0
Cap	0.00	3.00		0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
0	0.00			0		0		0
Total	$5.25	$3.25	$0.00	$37,900	$0	$8,000	$0	$42,000	$0
Cash Flows during	Y1		Y2		Y3		Y4		Y5		Y:1-5
	P1	P1+P2+P3	P1	P1+P2+P3	P1	P1+P2+P3	P1	P1+P2+P3	P1	P1+P2+P3	P1	P1+P2+P3
Cash collection from customers	$192,000	224,000	216,000	$252,000	240,000	$280,000	240,000	$280,000	240,000	$280,000	1,128,000	1,316,000
Cash payment for variable costs	84,000	97,000	94,500	109,125	105,000	121,250	105,000	121,250	105,000	121,250	493,500	569,875	43.30%	= Varaible Cost Ratio
Cash payments for fixed costs	37,900	37,900	37,900	37,900	37,900	37,900	37,900	37,900	37,900	37,900	189,500	189,500
Cash Inflow from Operations	$70,100	102,100	83,600	104,975	97,100	120,850	97,100	120,850	97,100	120,850	445,000	556,625
Cash payment for start-up expenses	8,000	8,000									8,000	8,000
Cash outflow to purchase LT assets	42,000	42,000									42,000	42,000
Cash Outflow for Investments	$50,000	$50,000									$50,000	$50,000
Net Cash Flow	$20,100	$52,100	83,600	104,975	97,100	120,850	97,100	120,850	97,100	120,850	395,000	506,625

Based on your DNA, choose the positioning that is more appropriate for your organization.

Here, you want to keep track of improvements in NCF due to strategic thinking.

For simplicity, we assume that the demand of P2 and P3 also grow at the same rate as that of P1.

CH7

CH 6: Uncertain Demand
CH 6A: Primary Product
Five-year demand	Net Cash Flow
94,000	395,000
84,600	331,550
75,200	268,100
65,800	204,650
56,400	141,200
47,000	77,750
37,600	14,300
28,200	-49,150
18,800	-112,600
9,400	-176,050
0	-239,500
Accounting Concept	Definition	Value
Intercept =	- (Fixed Operational Costs + Start-up Costs) =	-239,500
Slope =	Unit Contribution Margin (UCM) = Price - Unit Variable Cost =	6.75
Operating Leverage =	Fixed Costs / (Fixed Costs + Variable Costs) =	27.75%
Breakeven Point (BEP) =	(Fixed Operational Costs + Start-up Costs) / UCM =	35,481
Margin of Safety (MS) =	Current Demand - BEP =	58,519
Percentage Margin of Safety (PMS) =	MS / Current Demand =	62.25%
Degree of Operating Leverage (DOL) =	1/PMS =	1.6063
% Change in NCF =	DOL * % Change in Demand
% Change in Demand	% Change in NCF
20%	32.13%
10%	16.06%
0	0
-10%	-16.06%
-20%	-32.13%
CH 6B: Business as a whole
Five-year revenues	Net Cash Flow
1,316,000	506,625
1,184,400	432,013
1,052,800	357,400
921,200	282,788
789,600	208,175
658,000	133,563
526,400	58,950
394,800	-15,663
263,200	-90,275
131,600	-164,888
0	-239,500
Accounting Concept	Definition	Value
Intercept =	- (Fixed Operational Costs + Start-up Costs) =	-239,500
Slope =	Contribution Margin Ratio (CMR) = 1 - Variable Cost Ratio =	0.5670
Assumption =	Sales-mix ratio (P1:P2:P3) remains the same
Operating Leverage =	Fixed Costs / (Fixed Costs + Variable Costs) =	24.95%
Breakeven Point (BEP) =	(Fixed Operational Costs + Start-up Costs) / CMR =	422,425
Margin of Safety (MS) =	Current Revenue - BEP =	893,575
Percentage Margin of Safety (PMS) =	MS / Current Revenue =	67.90%
Degree of Operating Leverage (DOL) =	1/PMS =	1.4727
% Change in Revenues	% Change in NCF
20%	29.45%
10%	14.73%
0	0
-10%	-14.73%
-20%	-29.45%

DOL is a measure of risk in NCF as demand becomes more uncertain.

What percentage drop in revenues will wipe out all NCF.

How much can revenues drop before all NCF gets wiped out.

Point at which NCF = 0.

This is the percentage of fixed costs in the total operational costs.

Point at which NCF = 0.

How much can revenues drop before all NCF gets wiped out.

What percentage drop in revenues will wipe out all NCF.

DOL is a measure of risk in NCF as demand becomes more uncertain.

CH7

Net Cash Flow (NCF) - Demand

CH8

% Change in NCF - % Change in Demand

CH9

Net Casfflow - Revenues

CH10

% Change in NCF - % Change in Revenues

CH11

CH 7: Relevant Information
Focus on Value
Decision Maker:	You and Partner
Decision Goal:	Maximize Net Cash Flow
Available Options:	Reject	P1	P1+P2+P3
Think Incrementally
Benchmark Option	Reject
Option: P1	Start-up	End of Y1	End of Y2	End of Y3	End of Y4	End of Y5	Total
Incremental Benefit (IB) of P1
Cash Inflow from Operations		70,100	83,600	97,100	97,100	97,100	445,000
Cash Inflow from sale of assets						8,400	8,400
Incremental Costs (IC) of P1
Initial Cash Outflow	50,000						50,000
Opportunity Cost of Time							0
Opportunity Cost of Capital		0	0	0	0	0	0
Opportunity Cost of Resources							0
Incremental Value (IV) of P1	-50,000	70,100	83,600	97,100	97,100	105,500	403,400
Option: P1+P2+P3	Start-up	End of Y1	End of Y2	End of Y3	End of Y4	End of Y5	Total
Incremental Benefit (IB) of P1+P2+P3
Cash Inflow from Operations		102,100	104,975	120,850	120,850	120,850	569,625
Cash Inflow from sale of assets						8,400	8,400
Incremental Costs (IC) of P1+P2+P3
Initial Cash Outflow	50,000						50,000
Opportunity Cost of Time		0	0	0	0	0	0
Opportunity Cost of Capital		0	0	0	0	0	0
Opportunity Cost of Resources		0	0	0	0	0	0
Incremental Value (IV) of P1+P2+P3	-50,000	102,100	104,975	120,850	120,850	129,250	528,025
Suppose Benchmark Option is	P1
Option: P1+P2+P3	Start-up	End of Y1	End of Y2	End of Y3	End of Y4	End of Y5	Total
Incremental Benefit (IB) of P2+P3
Cash Inflow from Operations		32,000	21,375	23,750	23,750	23,750	124,625
Cash Inflow from sale of assets						0	0
Incremental Costs (IC) of P2+P3
Initial Cash Outflow	0	0	0	0	0	0	0
Opportunity Cost of Time		0	0	0	0	0	0
Opportunity Cost of Capital		0	0	0	0	0	0
Opportunity Cost of Resources		0	0	0	0	0	0
Incremental Value (IV) of P2+P3	0	32,000	21,375	23,750	23,750	23,750	124,625
IV of P1+P2+P3 = IV of P1 + IV of (P2+P3/P1)	528,025	=	403,400	+	124,625

This is the money making opportunities you are foregoing from the personal resources you are investing in your organization.

This is the money making opportunities you are foregoing for the capital you are investing in your organization. Until we get to CH 8, assume that the opportunity cost of capital is zero.

This is the income generating opportunities you are foregoing while working for your own organization.

At this point, the entrepreneurs can continue to manage their firms or choose to sell their firm. At the least, they should be able to sell their LT Assets. For simplicity, we have assumed it is 20% of the original value of the LT Assets.

CH12

CH 8: Opportunity Cost of Capital and Operational Risk
Focus on Value
Decision Maker:	You and Partner
Decision Goal:	Maximize the Present Value of Net Cash Flow
Available Options	Reject	P1 + P2 + P3
Think Incrementally
Benchmark Option:	Reject
Opportunity Cost of Capital
Risk adjustment
Discount Rate	0.00%
Discount Factor	1.00
Option: P1+P2+P3	Start-up	End of Y1	End of Y2	End of Y3	End of Y4	End of Y5	Nominal Value	Present Value
PV of Incremental Benefit of P1+P2+P3
Cash Inflow from Operations		102,100	104,975	120,850	120,850	120,850	569,625	569,625
Cash Inflow from sale of assets						8,400	8,400	8,400
PV of Incremental Costs of P1+P2+P3
Initial Cash Outflow	50,000	0	0	0	0	0	50,000	50,000
Opportunity Cost of Time		0	0	0	0	0	0	0
Opportunity Cost of Resources		0	0	0	0	0	0	0
Net PV (NPV) of P1+P2+P3	-50,000	102,100	104,975	120,850	120,850	129,250	528,025	528,025	= NPV
IRR of P1+P2+P3								209%	= IRR
Discount Rate	NPV
528,025	0.00%
0%	528,025
42%	169,291
83%	73,296
125%	33,551
167%	12,672
209%	0	=> IRR
250%	-8,455
292%	-14,480

This is the return your organization is giving you for the investment of your start-up cost. This is also the break-even discount rate, or the discount rate at which NPV=0.

This is the PV of the incremental NCF you make by investing in your organization compared to investing the start-up cost elsewhere for a return you require in cell B12.

This is the additional discounting you do to account for demand uncertainty, DOL and your risk aversion.

This is the next best use for the amount of start-up costs you need.

CH12

NPV - Discount Rate

CH13

CH 9: Incorporating Taxes
Marginal Tax Rate
Focus on Value
Decision Maker:	You and partner
Decision Goal:	Maximize future cash flow
Available Options	Reject	P1+P2+P3
Think Incrementally
Benchmark Option:	Reject
Opportunity Cost of Capital	0.00%
Risk adjustment	0.00%
Discount Rate	0.00%
Discount Factor	1.00
Cash inflow from operations		102,100	104,975	120,850	120,850	120,850
Start-up expense		8,000
Depreciation expense		6,720	6,720	6,720	6,720	6,720
Interest expense
Other tax-deductible expenses
Taxable Income		87,380	98,255	114,130	114,130	114,130
Income Taxes		0	0	0	0	0
Option: P1+P2+P3	Start-up	End of Y1	End of Y2	End of Y3	End of Y4	End of Y5	Nominal Value	Present Value
PV of Incremental Benefit of P1+P2+P3
Cash Inflow from Operations		102,100	104,975	120,850	120,850	120,850	569,625	569,625
Cash Inflow from sale of assets						8,400	8,400	8,400
PV of Incremental Costs of P1+P2+P3
Initial Cash Outflow	50,000						50,000	50,000
Opportunity Cost of Time		0	0	0	0	0	0	0
Opportunity Cost of Resources		0	0	0	0	0	0	0
Net PV (NPV) of P1+P2+P3	-50,000	102,100	104,975	120,850	120,850	129,250	528,025	528,025	= NPV
IRR of P1+P2+P3								209%	= IRR

IRR is lower because of the additional cash out flow.

NPV is lower because of the additional cash out flow to IRS.

The opportunity cost of time is lower because of the taxes the entrepreneurs have to pay on their alternate income.

Because the LT asset is being sold at book value, there is no capital gain, as such no capital gain taxes apply

Incremental Income Taxes = Incremental Taxable Income * Marginal Tax Rate

This is the tax bracket you are in. As such, any additional income from the organization will also be taxed at this rate.

CH 10: Optimal Financing
After-tax IRR	209%
Marginal tax rate	0%
Start-up Costs	50,000
Source of funds for start-up costs	Amount	CoC before tax	CoC after tax
Available from entrepreneurs		0.00%	0.00%
Borrowed from a bank (max 20%)		10.00%	10.00%
Available through credit card		18.00%	18.00%
Available through other investors	50,000	186.00%	186.00%
Weighted Average Cost of Capital (WACC)	50,000	186.00%	186.00%

The WACC of 10.2% is much smaller than the IRR after taxes of 73%. The difference is more than sufficient to compensate for the additional rtisk. Therefore, we will want to invest in the business.

Here we assume that a bank will not be willing to lend more than 20% of your start-up costs.

This is the amount of funds that partners themselves can contribute towards the start-up costs.

CH 11: Financial Statements
Cash Flow Statements for	Y1	Y2	Y3	Y4	Y5	Y:1-5
Cash collections from customers	224,000	252,000	280,000	280,000	280,000	1,316,000
Cash payments for variable operational costs	97,000	109,125	121,250	121,250	121,250	569,875
Cash payments for fixed operational costs	37,900	37,900	37,900	37,900	37,900	189,500
Cash payments to owner as salary	0	0	0	0	0	0
Cash payments to owner as resource rent	0	0	0	0	0	0
Cash payments for interest expense	93,000	93,000	93,000	93,000	93,000	465,000
Cash payments for tax expense	0	0	0	0	0	0
Cash payments for start-up expenses	8,000					8,000
Cash flow from operations	-11,900	11,975	27,850	27,850	27,850	83,625
Cash collections from sale of assets	0	0	0	0	8,400	8,400
Cash investment in LT assets	42,000	0	0	0	0	42,000
Cash flow from investments	-42,000	0	0	0	8,400	-33,600
Cash contributions by owners						0
Cash distributed as dividends	0	0	7,765	21,130	21,130	50,025
Cash borrowed as long-term debts	50,000					50,000
Cash paid to settle long-term debts	0					0
Cash flow from financing	50,000	0	-7,765	-21,130	-21,130	-25
Net cash flow	-3,900	11,975	20,085	6,720	15,120	50,000
Ending cash	-3,900	8,075	28,160	34,880	50,000	50,000
Marginal corporate tax rate	30%
Income Statements for	Y1	Y2	Y3	Y4	Y5	Y:1-5
Revenues	224,000	252,000	280,000	280,000	280,000	1,316,000
Variable operational expenses	97,000	109,125	121,250	121,250	121,250	569,875
Contribution margin	127,000	142,875	158,750	158,750	158,750	746,125
Fixed operational expenses	37,900	37,900	37,900	37,900	37,900	189,500
Owner salary expense	0	0	0	0	0	0
Owner resource rental expense	0	0	0	0	0	0
Interest expense	93,000	93,000	93,000	93,000	93,000	465,000
Start-up expense	8,000	0	0	0	0	8,000
Depreciation expense	6,720	6,720	6,720	6,720	6,720	33,600
Net Income before Taxes	-18,620	5,255	21,130	21,130	21,130	50,025
Tax expense	0	0	0	0	0	0
Net Income after taxes	-18,620	5,255	21,130	21,130	21,130	50,025
Balance Sheets as at the end of	Y1	Y2	Y3	Y4	Y5
Use of Funds
Cash	-3,900	8,075	28,160	34,880	50,000
Other current assets	0	0	0	0	0
Purchase cost of long-term assets	42,000	42,000	42,000	42,000	42,000
Less Accumulated depreciation	6,720	13,440	20,160	26,880	33,600
Long-term assets	35,280	28,560	21,840	15,120	0
Total Assets	31,380	36,635	50,000	50,000	50,000
Source of Funds
Current liabilities	0	0	0	0	0
Long-term liabilities	50,000	50,000	50,000	50,000	50,000
Contributed capital	0	0	0	0	0
Earnings	-18,620	5,255	21,130	21,130	21,130
Less Dividends	0	0	7,765	21,130	21,130
Retained earnings	-18,620	-13,365	0	0	0
Total Liabilities + Owner's Equity	31,380	36,635	50,000	50,000	50,000

Balance Sheet is the fundamental accounting statement. It is based on the accounting equation that source of funds (liabilities plus owner's equity) has to balance the use of funds (assets).

This number is the focus of many outsiders because it helps them predict the future profitability of the business.

Given the importance of the income number for outsiders, GAAP is careful not to overstate this number. As such, they have rules that are meant to slow down the recognition of revenues.

Income Statement goes after the economic income earned by a business. As such, this number becomes a useful predictor of a firm's future profitability.

CH 12: Transaction Analysis
Transactions:
Financing activities
1	Owners contributed capital to the business				0
2	Creditors loaned money				50,000
Investment activities
3	Invested in equipment (start-up costs)				42,000
4	Spent on other start-up expenses				8,000
Operational activities
5	Paid for variable operational costs on credit				97,000
6	Paid for fixed operational costs on credit				37,900
7	Offered product/service & collected money				224,000
8	Paid-off credit card bill for variable costs				97,000
9	Paid-off credit card bill for fixed costs				37,900
10	Paid-off interest expense				93,000
11	Paid-off tax expenses				0
12	Distributed dividends				0
13	Owner salary paid				0
14	Owner resource rent paid				0
Adjusting entries
15	Depreciation expense				6,720
Transaction Analysis
Use of Funds	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	Total $
CF from operations				-8,000			224,000	-97,000	-37,900	-93,000	0		0	0		-11,900
CF from investments			-42,000				0									-42,000
CF from financing	0	50,000										0				50,000
Cash																-3,900
Other current assets																0
Long-term assets			42,000				0								-6,720	35,280
Total Assets																31,380
Source of Funds
Current liabilities					97,000	37,900		-97,000	-37,900							0
Long-term liabilities		50,000														50,000
Contributed capital	0															0
Earnings				-8,000	-97,000	-37,900	224,000			-93,000	0		0	0	-6,720	-18,620
Dividends												0				0
Retained Earnings																-18,620
Total Liabilities plus Owner's Equity																31,380
FIN STs for the first year
Balance Sheets as at the end of	Y1
Use of Funds
Cash	-3,900
Other current assets	0
Purchase cost of long-term assets	42,000
Less Accumulated depreciation	-6,720
Long-term assets	35,280
Total Assets	31,380
Source of Funds
Current liabilities	0
Long-term liabilities	50,000
Contributed capital	0
Earnings	-18,620
Less Dividends	0
Retained earnings	-18,620
Total Liabilities + Owner's Equity	31,380
Income Statements for	Y1
Revenues	224,000
Variable operational expenses	-97,000
Contribution margin	127,000
Fixed operational expenses	-37,900
Owner salary expense	0
Owner resource rental expense	0
Interest expense	-93,000
Start-up expense	-8,000
Depreciation expense	-6,720
Earnings before taxes	-18,620
Tax expense	0
Net Income (after taxes)	-18,620
Cash Flow Statements for	Y1
Cash collections from sales	224,000
Cash payments for variable operational costs	-97,000
Cash payments for fixed operational costs	-37,900
Cash payments for interest expense	-93,000
Cash payments for tax expense	0
Cash payments for start-up expenses	-8,000
Cash flow from operations	-11,900
Cash collections from sale of assets	0
Cash investment in LT assets	-42,000
Cash flow from investments	-42,000
Cash contributions by owners	0
Cash paid as dividends	0
Cash borrowed as long-term debts	50,000
Cash paid to settle long-term debts
Cash flow from financing	50,000
Net cash flow	-3,900
Ending cash	-3,900

This number is the focus of many outsiders because it helps them predict the future profitability of the business.

Given the importance of the income number for outsiders, GAAP is careful not to overstate this number. As such, they have rules that are meant to slow down the recognition of revenues.

Income Statement goes after the economic income earned by a business. As such, this number becomes a useful predictor of a firm's future profitability.

This number must equal cell C70 above.

These liabilities are arising from the obligation to pay rent and salary to the owners for the use of their resources and time.

This number must equal cell B52 in CH 9.

Balance Sheet is the fundamental accounting statement. It is based on the accounting equation that source of funds (liabilities plus owner's equity) has to balance the use of funds (assets).

Cash flow statement simply restates these flow of cash which changed the cash balance of the business.

The amount of cash the business has at the end of a period gets reflected in the (end-of-period) balance sheet. How the firm moved from the previous period-balance to this period's balance is reflected in the cash flow statement.

Cash flow statement simply restates these flow of cash which changed the cash balance of the business.

Dividend payments require a Dividend policy in addition to meeting GAAP rules. GAAP: You cannot pay dividends exceeding the retained earnings. Dividend policy of MIT: Before paying dividends, the business must ensure that their ending cash will equal or exceed the initial- working-capital amount.

Cash flow statement simply restates these flow of cash which changed the cash balance of the business.

This is another example of the Matching Principle in Action. In order to prevent the overstatement of income, it says that part of the cost of generating revenue was the use of long-term assets which, as a result of being used, are losing value. As such, GAAP requires that the loss in value over the useful life of the long-term asset be spread across the periods that the asset is planning to be used: (1500-300) /(5 x 12) = $20 per operating cycle.

Find the correct amount of CH 5C.

CH 13: Return on Investment (ROI)
Over five years	Initial Investment		Start-up Costs		Annualized Sales		Annualized Earnings
	0	IM	50,000	TO	263,200.00	PM	10,005.00	ROI
		0.00		5.26		3.80%		0.00%
For the fifth year	Initial Investment		Start-up Costs		Annualized Sales		Annualized Earnings
		IM		TO		PM		ROI
		0.00		0.00		0.00%		0.00%

This is the amount of Assets the organization owns at the beginning of the fifth year or at the end of fourth year.

This is the Owner's Equity at the beginning of the fifth year or at the end of fourth year.

PM is a measure of the profitability of sales.

TO is a measure of productivity of assets (or start-up costs).

IM is a measure of financial leverage.

This is a measure similar to IRR, which can easily be calculated from the Financial Statements.

_1517589411.xls

Chart1

0.2

0.1

-0.1

-0.2

% Change in NCF - % Change in Demand

0.3212658228

0.1606329114

-0.1606329114

-0.3212658228

CH2

CH 2: Product or Service
Name of primary product or service	Game specific T shirts
Target market	Participants of SU Dome events
Their need that is served	Need to cheer for SU teams
Your assets that are utilized	Familiarity with dome events; international connections; EEE major
Partner's assets that are utilized	Student manager for SU Basketball; Marketing major

CH3

CH 3: Estimating Revenues
CH 3A: Marketing Plan
Product	T-shirt in a see-through plastic wrapping
Price	$10 per T shirt
Place	Sold on-line, in-stores and at busy spots on game days.
Promotion	Post Standard and TV / Daily Orange advertisements
CH 3B: Estimating Revenues
Target population	100,000
Price per unit	$10.00
Number of steady state consumers per year	5,000
Average yearly consumption per customer	4
Steady state demand per year	20,000
Year	Y1	Y2	Y3	Y4	Y5	Y:1-5
Demand Growth	80%	90%	100%	100%	100%	470%
Demand of P1	16,000	18,000	20,000	20,000	20,000	94,000
Price of P1	10.00	10.00	10.00	10.00	10.00	10.00
Revenues	160,000	180,000	200,000	200,000	200,000	$940,000
CH 3C: Demand Curve
Alternate price per unit	$12.00
Corresponding steady state demand per year	12,000
Price sensitivty	-4,000.00
Price elasticity	-2.00
Price	Demand
0.00	60,000
2.50	50,000
5.00	40,000
7.50	30,000
10.00	20,000
12.50	10,000
15.00	0
17.50	-10,000
20.00	-20,000
22.50	-30,000
25.00	-40,000
27.50	-50,000
30.00	-60,000
CH 3D: Maximizing Revenues over Price
Price	Revenues
$1,057,500	-4,000
0.00	0
2.50	587,500
5.00	940,000
7.50	1,057,500
10.00	940,000
12.50	587,500
15.00	0
17.50	-822,500
20.00	-1,880,000
22.50	-3,172,500
25.00	-4,700,000
27.50	-6,462,500
30.00	-8,460,000
Price per unit	$7.50
Steady State Demand per Year	30,000
Price sensitivty of demand	-4,000.00
Price elasticity of demand	-1.00
Year	Y1	Y2	Y3	Y4	Y5	Y:1-5
Demand Growth	80%	90%	100%	100%	100%
Demand of P1	24,000	27,000	30,000	30,000	30,000	141,000
Price of P1	7.50	7.50	7.50	7.50	7.50	7.50
Revenues	180,000	202,500	225,000	225,000	225,000	$1,057,500