### Create a StudySoup account

#### Be part of our community, it's free to join!

Already have a StudySoup account? Login here

# FIN303 TEST 1 STUDY GUIDE FIN303

UM

GPA 3.5

### View Full Document

## About this Document

## 130

## 0

## Popular in Corporate Finance Management

## Popular in Finance

This 21 page Study Guide was uploaded by Giulia Dias Roncoletta on Monday February 15, 2016. The Study Guide belongs to FIN303 at University of Miami taught by Douglas R. Emery in Winter 2016. Since its upload, it has received 130 views. For similar materials see Corporate Finance Management in Finance at University of Miami.

## Similar to FIN303 at UM

## Popular in Finance

## Reviews for FIN303 TEST 1 STUDY GUIDE

### What is Karma?

#### Karma is the currency of StudySoup.

#### You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!

Date Created: 02/15/16

FIN303 NOTES CHAPTER 4 4.1 RATES OF RETURN AND NET PRESENT VALUE Returns: Rate of Return = CF + (End. Value - Beg. Value) Beginning Value Realized Returns: rate of return actually earned on an investment during a given time period. - an outcome, not a prediction - observed from actual investment - you can only react to it Expected Return: rate of return you expect to earn if you make the investment - the return you expect to get from an investment - helps you make investing decision Required Return: rate of return that exactly reﬂects the riskiness of the expected future cash ﬂow - return market requires on invest. of identical risk - the market compares prices and risk of all other investments - the fair return for an investment Net Present Value - NPV: NPV = PV of future CFs - Cost Positive: a positive NPV increases wealth because it means the asset invested on is worth more than it costs. Earn more than the appropriate return. Negative: a negative NPV decreases wealth because it means the asset costs more than it’s worth. Zero: an NPV of 0 earns the required return and it’s “fair” - NPV is measured on a benchmark of “normal” market return - it provides framework for decision making on investments - measures the value created or lost by ﬁnancial decisions - maximize shareholder’s wealth = strive for positive NPV “fair price” a price that does not favor the buyer or the seller - Principle of Capital Market Efﬁciency - all securities are fairly priced. - makes the NPV 0 - does not mean zero return, but required return. - Principle of Risk Return Trade off - more risk = more return. * If markets were perfect required and expected return would be the same, because all securities would be fairly priced and have an NPV of 0. * Realized rarely equals Expected return, but you can measure risk, if there’s a great difference between the rates of return the higher the risk, risk is low when difference is slight. 4.2 VALUING SINGLE CASH FLOWS Future Values: n FV n PV(1+r) = PV(FVF ) r,n Future Value: value at the end of a given time period. Compound Interest: method of interest computation wherein interest is earned on both the original investment and on the reinvested interest. Simple Interest: method of interest computation wherein interest in earned on only the original investment. - use of simple interest has largely disappeared Future Value Factor is the (1+r) part of the FV equation, is the value $1 is going to grow to at a rate of r for n periods. - negative sign in FV is due to the fact that the formula sums up to 0. Present Values: PV= FV [ n ] = FV (PnF ) r,n (1+r)n Present Value: an amount invested today at r per period that would provide a given future value at time n. - the larger the r the smaller the present value - more time until cashﬂow, smaller the present value (for positive r ) Solving for a Return: r = [FV n 1/n- 1 [PV] 4.3 VALUING ANNUITIES Future Value of an Annuity: FVA nPMT [(1+r) - 1] r Annuity: series of qual, periodic cash ﬂows, which occur regularly. -majority of annuities have end-of-period payments Ordinary Annuities: annuities whose payments occur at the end of each period Deferred Annuities: annuities whose ﬁrst payment is different than one period in the future Annuity Due: annuities whose payments are made at the beginning of the period - each subsequent payment earns interest for one less period than the previous one - the last payment does not earn any interest because it occurs at the end of annuity Present Value of an Annuity: n PVA =nMT [(1+r) - 1] r (1+r) Present Value of an Annuity: If you borrow money and are paying back these are your present value payments: PMT=PVA [r (1+r) ] n n n (1+r) - 1 If you save money, the accumulated amount is the future value, therefore these are your receivables PMT= FVA n r n [(1+r) - 1] Amortizing a Loan: Loan Amortization Schedule: shows how a loan is paid overtime, aka the relationship between its payments, principal, and interest rate. Create a Schedule: (1) star with amount borrowed (2) add ﬁrst period’s interest (3) subtract the ﬁrst periods payment (4) results in remaining balance = starting amount for 2nd period (5) repeat until remaining balance is 0 at last period. Valuing Deferred Annuities: - Deferred annuities start at a time other than right away, therefore they start at t=1 not t=0 - PV of an annuity can be calculated by ﬁrst calculating the annuity’s future value, then calculating the present value of thats lump-sum future value. (1) ﬁnd future value using N= when payments are received, plug in payments (2) use FV (-) to ﬁnd real PV, use N=whole period, and pmt=0 Perpetuities: PVA perpetuityMT r Perpetuity: is an annuity that goes on forever. - accurate approximations of long term annuities. Valuing an Annuity Due: - has a higher present value than ordinary annuities - higher future value because each pay has an additional period to compound - value an annuity due, but multiplying the value of a comparable ordinary annuity and multiply it by (1+r) 4.4 MULTIPLE EXPECTED FUTURE CASH FLOW - NPV equals the sum of the present value of all cash ﬂows. - Or use “rollback” and discount the r back one period starting from last cashﬂow - Use FV and PV formulas to ﬁnd the exact payment at any time period. 4.5 COMPOUNDING FREQUENCY Annual Percentage Rate (APR) APR = (m)(r) APR is the periodic rate times the number of periods in a year - a nominal rate “in name only” Compound Frequency: how often an interest is compounded - monthly, weekly, daily, annually - period rare is an effective rate (r ) - m Annual Percentage Yield (APY) (1) APY = [ 1+ APR ] - 1 m (2) APY = Annual Interest / Principal APY is the effective (true) annual rate of return. - rate you actually earn in one year - if APR is compounded annually, it equals APY Continuous Compounding: APY = e APR - 1 - When the m (frequency) becomes too large (minutes, seconds) compounding becomes essentially continuos - Just use a very large value for m like 100,000 and you’ll get the same number as a continuous compounding APY 4.6 PARTIAL TIME PERIODS - read the book cuz its just examples and i cant really take note on it, it’s very straight forward 4.7 EVALUATING “SPECIAL-FINANCING” OFFERS Special Financing Offers: used as part of sales promotion, consumers purchases it as a package. It’s a promotional gimmick - ﬁrm is lowering the effective price to encourage sales. - how much does the interest savings lowers the price? - (1) market interest rate for such loans, - market interest provides a measure of opportunity cost of the special ﬁnancing - use market rate to compute the real price of the product - if PV is smaller than cash price, special ﬁnancing is a better deal - CHAPTER 10 10.1 AN OVERVIEW OF ESTIMATING CASH FLOWS Capital Budgeting Cash Flows: 5 Basic Concepts : (1) cost and beneﬁts are measured in terms of CF - not income (2) cash ﬂow timing is CRITICAL. money is worth more the sooner u get it (3) CF must be measured on an incremental, or marginal basis - only future expenditures and revenues are relevant to decision (4) expected future cash ﬂow is measured in an after tax basis (net gain) (5) Financing costs are not explicitly identiﬁed - the discount rate includes in it the opportunity cost for ﬁnancing the project 10.2 CALCULATING INCREMENTAL CASH FLOWS 4 categories of CF: (1) net initial investment outlay (2) expected future net operating cash ﬂow (3) non operating CF to support the project (4) Net salvage value, after-tax total amount of cash received and/or spent when project ends. (1) Net Initial Outlay: - broken-down into cash expenditures for the new capital assets, changes in net working capital, cash ﬂow from sales of old equipment, tax impact on sale of equipment. (1) cash paid for new assets = - I (2) Increase in net working capital = - W (3) cash received on sale of old equip = S (salvage value) (4) Tax paid (saved) on sale of ^ = - T(S-B) NET CF for I I = - I - W + S - T(S-B) - An increase in working capital is the difference between the additional short term assets required minutes the additional short term liabilities generated. - Working capital is the money you need initially to get things going, but will serve as a base for your proﬁt, and be returned at the end of the project. - Increase in working capital are outﬂows - Decrease in working capital are inﬂows - difference is the time value money cost of using the working capital during the project’s life. Tax Considerations: Two important considerations: (1) are assets being expensed or capitalized (2) tax consequences of selling Capitalizing: recording the outlay as an asset, and allocating (depreciating) the cost over future time periods. It leads to depreciation expense, allocates costs of assets to 2 or more periods. Expensed: Cash expenditures that are immediately recognized for tax purposes. Do not have any subsequent tax consequences, earliest recognized, earliest taxed. - ﬁrms wish they could expense every asset, but due to tax purposes, some assets are required to be capitalized. Whatever you can expense, do. Investment Tax Credit: credit again taxes due based on new capital investments Net Operating Cash Flow: Net Operating CF (CFAT) = R - E - T( R - E - D) R = change in periodic revenue E = change in periodic cash operating expense D = change in depreciation (1) ﬁnd cash ﬂow as operating cash ﬂows after tax plus the deprecation tax shield (2) ﬁnd he cash ﬂow as net income plus depreciation Non operating CF: CFs not associated with operations, can occur are various points during the project. - expensed non-operating cf, are adjusted to tac by being multiplied by (1-T) Net Salvage Value: Net salvage value: is the after-tax net cash ﬂow from terminating the project. 4 parts - sales of asset, taxes owed or saved, cleanup/removal expenses(REX), realize of net working capital Tax Liability: T(S-B) - clean up/removal expenses (REX), are expensed, therefore taxed immediately (1 -T) - net working capital is not adjusted to taxes - added cash ﬂow (1) cash received on sale = S (2) tax paid (saved) = - T(S-B) (3) AT clean up/removal = - (1 - T)REX (4) Release of W/C = W Net Salvage Value = S - T(S - B) - (1 - T)REX + W Salvage Value = S - REX 10.3AN EXAMPLE OF INCREMENTAL CASH FLOW ANALYSIS - Pre-tax operating savings = change in expenses. (negative) - Erosion when the sales of a new product reduce the sales of an existing product - Enhancement is when an interaction among products causes the increase in value 10.4 INFLATION - Expectations of inﬂation affect required returns. - Present value depends on required return and expected cash ﬂows. If any of this change, at least one more should change with it. Normal Terms: when an estimate includes inﬂation Real Terms: when inﬂation is excluded - match the required return to the cash ﬂows - discount nominal at nominal required return, and discount real at real return rr= real required return rn= nominal required return i = inﬂation (1+r ) = (1+r )(1+i) n r n = rr+ i + rr 10.5 A LITTLE MORE ABOUT TAXES - a ﬁrms should use the depreciation method that provides the largest present value of depreciation tax credits. - MACRS vs STRAIGHT LINE Depreciation 10.6 EVALUATING REPLACEMENT CYCLES Replacement Cycle: Replacement Cycle: is a routine patterns that allows the machines to be up to date with technology and be replaced when the time comes. Equivalent Annual Cost (EAC): is the equivalent cost per year of owning an asset over its entire life. - 2 step application of TVM (1) calculate present value of all costs associated with asset throughout its life - purchasing price, maintenance costs, operating costs, (2) Net initial outlay be C0 and the yearly CFAT costs be C1, C2…Cn, where n is length of assets life. - smaller the EAC, the better the investment, that means the annual cost of the machine is lower. - EAC measures the replacement frequency as well Equivalent Annual Annuities: Equivalent Annual Annuity: is a useful measure for indeﬁnitely long projects, it’s an annualized amount. - use same equations as EAC and TC, but replace: EAC = EEA TC = NPV CHAPTER 22 22.1 OVERVIEW OF WORKING CAPITAL MANAGEMENT Working Capital Management: manage the decision making for investments, making sure shareholder’s wealth is maximized, and investments have a positive NPV. Financing Working Capital 3 different approaches to ﬁnancing working capital (1) Maturity Matching: the ﬁrm hedges its risk by matching the maturity of its assets and liabilities, ﬁnances long-term debt with long-term equity, short-term liability to short term asset. Relies on short term ﬁnancing funds for short term assets, long-term ﬁnancing for long- term assets, and permanents with long-term. (Base-Case Scenario) (2) Conservative: the ﬁrms depends on all its long-term assets to ﬁnance all of the ﬁrms permanents assets, and some of its current assets. They use long term because the funds are always available. Builds a margin of safety. (3) Aggressive: the ﬁrm uses more short-term ﬁnancing than long-term, it’s supposed to raise proﬁtability. high risk, high returns.. * If interest rates rise, aggressive approach ﬁrms are in a bad place, since the interest rates of long-term ﬁnancing are locked in lower, they will have lower ﬁnancing costs, BUT * if interest rates fall, aggressive approach wins, since the cost for the interest rates for long-term ﬁnancing might be locked high * a ﬁrm with ready capital market access can be more aggressive * a ﬁrm without ready capital market access should be more conservative - expect a decline in interest rates =aggressive approach because can shorten the average maturity of the ﬁrms debt by matching long term debts with short term assets - expect a rise in interest rates = conservative approach because can lengthen the average maturity of the ﬁrms debt by ﬁnancing more with long term assets rather than short term debts. 22.2 CASH CONVERSION CYCLE Cash conversion cycle: the length of time between the payment of A/P (accounts payable) and the receipt of cash from A/R (accounts receivable) Cash Inventory Receivables Payable Conversion = Conversion + Collection - Deferral Cycle Period Period Period Inventory Conversion Period: is the average time between buying inventory and selling goods Inventory Conversion Period = Inventory . Cost of Sales/365 Receivables Collection Period: (or Days’ sales outstanding - DSO) is the average number of days it takes to collect on account receivable. Receivables Collection Period = Receivables . Sales/365 Payable Deferral Period: is the average length of time between the purchase of the materials and labor that go into inventory and the payment of cash for these materials and labor. Payables Deferral Prd = Accounts Payable + Wages, beneﬁts, and payroll taxes payable (Cost of sales + Selling, general, and administrative expenses)/365 22.3 CASH MANAGEMENT - a ﬁrm’s cash management can be broken into two parts, (1) how much liquidity (cash plus marketable securities) should the ﬁrm have? (2) what should be the relative proportions of cash and marketable securities in maintaining that liquidity? Demand For Money - Three basic motives for holding cash: (1) Transaction Demands: everyday payments like wages, raw materials, taxes, and interest. This exists due to imbalances of cash in and out ﬂow. The larger the ﬁrms, the more transactions, the more closely (timely) they match, the less cash needed to maintain liquidity. (2) Precautionary Demands: the essential margin of safety required to meet unexpected needs. The more uncertainty in cash in and out ﬂows, the more precautionary needed. (3) Speculative Demand: based on desire to make proﬁt out of unexpected opportunities that require cash. - Readily available bank borrowing can be used for speculative demand, there is no need to hold cash for this reason anymore. Compensating Balance: an account balance that the ﬁrm agrees to maintain. Provides indirect payment to the bank for its loans and other services. - Now direct fees are more common. Float Management: Float: the difference between the available or collected balance at the bank and the ﬁrm;s book or ledger balance. Float = Available balance - book balance Disbursement Float: when writing a check, after written, your book or ledger balance is reduced by the amount of the check, but your available balance at the bank is not reduced until the check clears. Collection Float: when you receive a check and deposit it to the bank, the time between the funds being credited to your account from the moment you deposited it to the bank is called collection ﬂoat (the amount). Bank balance only changes when funds are credited, only book balance changes. 22.4 SHORT-TERM FINANCING Short-term funds: are debt obligations that were originally scheduled for repayment in one year. Finance seasonal or temporary needs. Intermediate funds: are debt obligations that were originally scheduled to mature between 1-10 years from issuing date. Concerned with the long term proﬁtability of the company. 3 Main Sources of Short-Term Funds: (1) Trade Credit - borrowing from suppliers: - is credit extended from one ﬁrm to another, usually granted on the sales of goods and services (since permitted to pay by delivery). - Largest single source of short-term funds for businesses, 1/3 of current liabilities of non ﬁnancial ﬁrms. (specially for small ﬁrms) - Cash Discount: offered if payment is made more quickly - “2/10 net 30” means the buyer can take a 2% cash discount if payment is made within 10 days (discount period). Otherwise, full amount is due in 30 days (net period). - if cash discount was offered but not taken advantage of, the trade credit has a cost. - the “real” price is considered to be the discounted price, but then the discount rate is technically the interest of the borrowing of the real price. Original $100, w discount 2% = $98 = real price, technically borrowed $98, with a $2 worth of interest - APR for trade credit: is measured by dividing the cost by the borrowing amount, we established that the borrowing amount in a “2/10 net 30” of $100, was $98, therefore the cost was $2 (worth of interest) so the ﬁrst part to measure the APR is to divide $2/98. Then multiply by the borrowing period, which is net period - discount period, in this case (30-10=20), use that number to divide the total periods in a year (365) = (365/20). APR = (Periodic Rate)(# of periods in a year) - APY for trade credit: is a better measure of the true cost of the loan. Therefore to ﬁnd the APY, (in calc) for N use the borrowing period (30-10=20) divided by 365 (how many periods in a year), use the borrowing amount ($98) as the PV, and (-)$100 (the real price with interest) as the FV, 0=PMT, and compute for I. That will give you the APY of the cash discount. - trade credit is more ﬂexible, therefore there are less consequences when payments are late. - “stretches” happen when the company extends the net period without any increase in cost, therefore it lowers the ﬁnancing costs. - “2/10, net EOM” end of the month, 10 days = 10th of the month (2) Bank Loans - borrowing from banks: - Second largest source of shot-term ﬁnancing, but also provide intermediate-term ﬁnancing. - Creditworthy customers receive unsecured loans - Credit risky customers are asked to provide some security such as a lien on receivables or inventory. - 3 forms of short-term unsecured bank loans (1) a speciﬁc transaction loan: loan to build houses will be paid back when houses are sold. (2) a line of credit: agreement of max loan balance permitted at once, renewals granted annually if credit remains acceptable. require to be out of bank debt for certain amount, bank is not legally obligated to advance funds. (3) a revolving credit: agreement to borrow a maximum amount at any time during a speciﬁed period. Commitment fee is required, to pay for the banks availability of cash for you during that time. (*) “self-liquidating”: lender expects to generate sufﬁcient cash with assets being purchased to repay loan within a year. - Bank Term Loans are intermediate-term debts, - A Bank Term Loanis a loan for a speciﬁed amount that required the borrower to repay according to speciﬁc schedule. (1-10 years) Repay at regular intervals in equal installments. - Balloon Payment: a large ﬁnal payment after many payments - Bullet Maturity: require payment in one lump-sum, interest is paid periodically, but the principle is paid in one lump sum at the end. - Carry ﬂoating interests, that ﬂoat with the bank’s prime rate -Prime Rate is a benchmark rate that banks may use to price loans and charged to their best most creditworthy clients. - “money market rates” are offered when banks want to compete with commercial paper market. - Compensating Balances: banks require if to be between 10% and 20% of the size of the loan. it’s a required average deposit balance during a particular interest period. - Discount Loans: require the borrower to pay the interest in advance. - because of TVM, the interest cost is higher when paid in advance, and if compensating balance was also required, the true interest cost would be even higher. - APY for discounted installment loans: (paid in multiple payments) is calculated by solving for the periodic rate, then annualizing it. - ﬁnd the discount by multiplying the interest rate by the amount of months I.E. 12% 3 months, discount = 3% = (.12)(3/12) - Use cashﬂows: - “Floating lien” is used as security for bank loans (3) Commercial Paper - selling short-term debt securities in the open market: - only available for the largest, most creditworthy companies - this is an unsecured promissory note with a maturity of 270 days, unless speciﬁed otherwise by the Securities and Exchange Commission. - Sold either directly to through dealers (.05% commission annually) - 20% of all commercial paper is sold directly to investors - permanent source of funds for large ﬁnance companies. - Calculations for APR and APY are the same as for discounted loans - High rating papers (P-1/A-1+) = lowest cost of borrowing and the smallest chance of interrupted market access. CHAPTER 23 23.1 ACCOUNTS RECEIVABLE MANAGEMENT 2 Types of Credit: (1) Trade Credit - between ﬁrms, creates accounts receivable for the supplier and account payable for the buying ﬁrms. (2) Consumer Credit: retail credit, ﬁrms sells good or service to a consumer without simultaneous payment. Basic Credit-Granting Decision: Positive NPV Decision: NPV = PV of future CF - Outlay NPV = pR - C (1+r)t - at time zero, we invest C in a credit sale - the sale amount is R - the probability of payment is p - the expected payment is pR - payment is expected at time t - the required return is r Calculate the (zero-NPV) p* - If a credit customer has a payment probability exceeding p* then granting credit has a positive NPV. p* = C (1+r)t R Credit Policy Decisions: - Credit policy affects a company’s revenues and costs. - Include (1) choice of term credit (2) setting evaluation methods and credit standards (3) monitoring receivables and taking actions for slow payments (4) controlling and administering the ﬁrm’s credit functions. Credit Terms: - Credit Terms: are the contract between the supplier and the credit customer specifying how the credit will be repaid. - Credit Period: amount of days the customer has to repay - Discount Period: amount of days customer has to repay with discount - Discount: percentage rate discounted if payment paid during discount period. - Invoice Date: the date the goods are shipped. - Open Account Basis: customers purchase what they want. 23.2 CREDIT STANDARDSAND CREDIT EVALUATION Low probability of payment, late collection period, or high pv of collection costs, cause NPV to * decrease. Source of Credit Information: (a) Internal Sources: 1. credit application with references 2. applicants previous payment history, previously extended credit 3. information from sales rep and other employees (b) External Sources: 1. recent years’ ﬁnancial statements 2. reports from credit rating agencies 3. credit bureau reports 4. industry association credit ﬁles Evaluating credit application: (a) judgmental: uses credit info and knowledge and experience (b) objective: uses numerical cutoffs and scores 5 C’s of Credit: These are ﬁve general factors that credit analysis often consider when making credit granting decisions. (1) Character: the commitment to meet credit obligations. (measured by: payment history) (2) Capacity: the ability to meet credit obligations with current income (measured by: income statement) (3) Capital: the ability to meet credit obligations from existing assets if necessary (measured by: net worth) (4) Collateral: collateral that can be repossessed in case of nonpayment. (5) Conditions: general/industry economic conditions. Credit Scoring Models: Credit Scoring: combines several ﬁnancial variables into a single score that measures creditworthiness. S = w1X1 + w2X2 + w3X3 + w4X4 X1 = net working capital/sales (%) X2 = debt/assets (%) X3 = assets/sales (%) X4 = net proﬁt margin (%) * Positive X1, X3, and X4 mean that the high value results in a higher credit score * Negative X2 means that a higher debt/asset ration reduces the credit score Advantages of Credit Scoring Models: - quickly differentiates a good customer from a bad customer - allow different loan processors - they are objective and avoid bias discrimination Disadvantages of Credit Scoring Models: - it’s as good as the payment records used to construct the model - models have to be updated occasionally - works best in large population of loan applicants 23.3 MONITORING ACCOUNTS RECEIVABLE Aging Schedules: Aging Schedule: is a table showing the total dollar amounts and the percentages of total accounts receivable that fall into several age classiﬁcations. (0-30 days old, 30-60 days old, 60-90 days old, and over 90 days old) Average age of accounts receivable: the average age of all of the ﬁrm’s outstanding invoices. - Calculate by using the percentage of each group in the aging schedule, then get the average date for each group, 0-30 = 15, then multiply the weight by the average date. - changes in credit terms, payment habits, or sales levels can increase or decrease the average date as well as the aging schedule. Collection Fraction and Receivables Balance Fractions: * Measures used to monitor the quality of receivables. (1) Collection Fractions: are the percentages of sales collected during various months. - this checks if collections are faster or slower than expected. (2) Receivables Balance Fractions: are the percentages of a month’s sales that remain uncollected at the end of the month of sale and at the end of the succeeding months. * These are always expressed as a percentage of original sales. * Better measure of quality than aging schedules particularly when sales are increasing/ decreasing. * You learned in class how to compute this. Pursuing Delinquent Credit Customers: Steps for a typical collection process: (1) Letters: a friendly reminder should be sent out (2) Telephone Calls: after ﬁrst couple of letters were ignored, customer is phones (3) Personal Visits: request payment in person (4) Collection Agencies: specialized agencies in collecting past due accounts (5) Legal Proceeding: if bill is large enough, legal action may be used. Changing Credit Policy: Credit Policy can be changed by altering terms, standards, or collection practices. It can affect sales, cost of goods sold, bad debt expenses, carrying costs on accounts receivable and other administrative costs. NVP of credit policy change calculation: - calculate original NVP, then new, then the difference. 23.4 INVENTORY MANAGEMENT The Economic Order Quantity Model: EOQ MODEL: - units are removed from inventory at constant rate S (rate units are sold) - ﬁxed reordering cost F per order - cost to carry a unit in inventory for an entire period is C - assumes constant inventory usage - inventory begins at Q units - Total annual costs = ordering costs + carrying costs Total Cost = F (S/Q) + C (Q/2) * an increase in Q will increase carrying costs but decrease ordering costs. * minimize cost by balancing the two cost components with EOQ .5 EOQ = (2FS/C) Be sure to know how to calculate all this: 1. average inventory = EOQ/2 2. # orders per year = S/EOQ 3. time interval between orders = EOQ/S 4. annual ordering cost = F(S/EOQ) 5. annual carrying cost = C(EOQ/2) 6. Total cost Quantity Discounts: * If discounts exceed the cost of the extra inventory, then you should increase the order size to get the discounts Total Cost = F (S/Q) + C (Q/2) - dS d = dollar price discount per unit * ordering large quantities and getting price discount. Inventory Management with Uncertainty: * EOQ makes a demand assumption: future demand id known with certainty, inventory is used at a constant rate, and delivery is instantaneous. * Firms protect themselves from uncertainties by maintaining safety stocks stock-outs occur when ﬁrm cannot immediately make a sale due to lack of inventory * Reorder Point = (Expected Lead-Time Demand) + (Safety Stock) *total costs with uncertainty. Annual Costs = Ordering Costs + Carrying Costs + Stockout Costs Stockout Costs = probability of a stockout (cost of a stockout) *a larger safety stock increases inventory carrying costs because the average inventory level is equal to EOQ/2 + the safety stock. ABC System of Inventory Control: * This system categorizes inventory into one of three groups: A,B, or C, on a basis of critical need. * Most important are items A - 10% of items, make up for 80% of inventory revenue Materials Requirement Planning (MRP) Systems: * computer based systems that plan backward from the production schedule to make purchases and manage inventory. * no interruptions due to stockouts. Just-In-Time Inventory Systems: * Reduces inventory, materials should arrive exactly when they are needed in the production process. * Success of JIT depends on these factors: (1) Planning Requirements: integrated plan for entire ﬁrm (2) Supplier Relations: must work closely with suppliers (3) Setup Costs: reduce the length of production runs. (4) Other cost factors: opportunity costs is high, better quality and monitoring (5) Impact on Credit Terms: eliminate costs afﬁliated with paper CHAPTER 24 24.1 THE FINANCIAL PLANNING PROCESS - How does the operating income respond to increase in output - a ﬁrms total sources of funds must equal its total uses of funds in any ﬁnite planning period. The Financial Plan Financial Planning: is a process of evaluating the impact of alternative investing and ﬁnancing decisions. - it has inputs, a model, and outputs - inputs: projection of sales, collections, costs, interest rates, and exchange rates - model: mathematical formula with a relationship between in and out puts - outputs: pro forma ﬁnancial statements Pro Forma Financial Statements: are projected (forecasted) ﬁnancial statements Budget: is a detailed schedule of a ﬁnancial activity, such as an advertising budget, etc. A Model’s Planning Horizon: is the length of time its projects into the future. (short <5, long 5>) A complete ﬁnancial plan includes, at a minimum: 1. clearly stated strategic, operating, and ﬁnancial objectives 2. assumptions on which the plan is based 3. descriptions of the strategies 4. contingency plans for emergencies 5. categorized budgets 6. ﬁnancing program 7. period by period pro forma ﬁnancial statements Bottom Up and Top Down Planning: Bottom Up Planning: starts at the production level or product and proceeds upward through the plant and division levels to top management. Ideas are added, modiﬁed, and deleted at each level. Top Down Planning: starts with the ﬁrms top management and its strategic plans and goals proceeds downward though the organization’s levels. * Good planning includes both types of planning. 3 Phases of Financial Planning: (1) formulating the plan: should be formulated by using the bottom up top down planning (2) implementing the plan: budges, resources, operating policies - ﬂexibility (3) evaluating the plan: overall performance to the ﬁnancial plan Beneﬁts of the Financial Plan: (1) Standardizing assumptions: make it possible to compare alternative plans (2) Future Orientation: generates new ideas and eliminates bad ones (3) Objectivity: increases the objective pursuit of the plan (4) Employee Development: it includes inputs from all employees (5) Lender Requirements: details necessary for borrowing (6) Better Performance Evaluation: provides a benchmark (7) Preparing for Contingencies: ready for unlikely outcomes 24.2 CASH BUDGETING Cash Budgeting: is the process of projecting (forecasting) and summarizing a ﬁrm;s cash inﬂows and outﬂows expected during the planning horizon. - a positive net cash ﬂow can increase cash, reduce outstanding loans, - are used in short-term plans 24.3 PRO FORMA FINANCIAL STATEMENTS Percent of Sales Forecasting Method: a shortcut to pro forma statements and budgets. Easy method to estimate the funds required to ﬁnance growth. Additional Financing Needed (AFN) = (Required increase in assets) - ( Increase in liabilities) - (Increase in retained earnings) AFN = (A/S) g S 0 (L/S) g S -0M[(1+g)S - 0] AFN = additional ﬁnancing needed A/S = increase in assets required per dollar increase in sales L/S = increase in liabilities required per dollar increase in sales S 0 sales for the current year g = growth in sales M = net proﬁt margin on sales D = cash dividends planned for common stock Cash Flow Break-Even Point: is the point below which the ﬁrm will need either to obtain additional ﬁnancing, or to liquidate some of its assets to meet its ﬁxed costs. - it forces the company to be ready for contingencies - Control risk by: (1) change its ﬁnancial leverage (2) change its operating leverage and its break even point (3) change some combination of the two. - control risk by creating contingency plans for dealing with bad outcomes. Alternatives for Inadequate Funds: 1. Reduce the growth rate: manageable level by not fully meeting the demand for its product, raise selling price. 2. Sell Assets: assets which aren't required to run the ﬁrm 3. Obtain New External Financing: 4. Reduce or stop paying dividends

### BOOM! Enjoy Your Free Notes!

We've added these Notes to your profile, click here to view them now.

### You're already Subscribed!

Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'

## Why people love StudySoup

#### "I was shooting for a perfect 4.0 GPA this semester. Having StudySoup as a study aid was critical to helping me achieve my goal...and I nailed it!"

#### "I made $350 in just two days after posting my first study guide."

#### "Knowing I can count on the Elite Notetaker in my class allows me to focus on what the professor is saying instead of just scribbling notes the whole time and falling behind."

#### "Their 'Elite Notetakers' are making over $1,200/month in sales by creating high quality content that helps their classmates in a time of need."

### Refund Policy

#### STUDYSOUP CANCELLATION POLICY

All subscriptions to StudySoup are paid in full at the time of subscribing. To change your credit card information or to cancel your subscription, go to "Edit Settings". All credit card information will be available there. If you should decide to cancel your subscription, it will continue to be valid until the next payment period, as all payments for the current period were made in advance. For special circumstances, please email support@studysoup.com

#### STUDYSOUP REFUND POLICY

StudySoup has more than 1 million course-specific study resources to help students study smarter. If you’re having trouble finding what you’re looking for, our customer support team can help you find what you need! Feel free to contact them here: support@studysoup.com

Recurring Subscriptions: If you have canceled your recurring subscription on the day of renewal and have not downloaded any documents, you may request a refund by submitting an email to support@studysoup.com

Satisfaction Guarantee: If you’re not satisfied with your subscription, you can contact us for further help. Contact must be made within 3 business days of your subscription purchase and your refund request will be subject for review.

Please Note: Refunds can never be provided more than 30 days after the initial purchase date regardless of your activity on the site.