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Corporate finance Slide 1 Corporate finance Slide 2 Corporate finance Slide 3 Corporate finance Slide 4 Corporate finance Slide 5 Corporate finance Slide 6 Corporate finance Slide 7 Corporate finance Slide 8 Corporate finance Slide 9 Corporate finance Slide 10 Corporate finance Slide 11 Corporate finance Slide 12 Corporate finance Slide 13 Corporate finance Slide 14 Corporate finance Slide 15 Corporate finance Slide 16 Corporate finance Slide 17 Corporate finance Slide 18 Corporate finance Slide 19 Corporate finance Slide 20 Corporate finance Slide 21 Corporate finance Slide 22 Corporate finance Slide 23 Corporate finance Slide 24 Corporate finance Slide 25 Corporate finance Slide 26 Corporate finance Slide 27 Corporate finance Slide 28 Corporate finance Slide 29 Corporate finance Slide 30 Corporate finance Slide 31 Corporate finance Slide 32 Corporate finance Slide 33 Corporate finance Slide 34 Corporate finance Slide 35 Corporate finance Slide 36 Corporate finance Slide 37 Corporate finance Slide 38 Corporate finance Slide 39 Corporate finance Slide 40 Corporate finance Slide 41 Corporate finance Slide 42 Corporate finance Slide 43 Corporate finance Slide 44 Corporate finance Slide 45 Corporate finance Slide 46 Corporate finance Slide 47 Corporate finance Slide 48 Corporate finance Slide 49 Corporate finance Slide 50 Corporate finance Slide 51 Corporate finance Slide 52 Corporate finance Slide 53 Corporate finance Slide 54 Corporate finance Slide 55 Corporate finance Slide 56 Corporate finance Slide 57 Corporate finance Slide 58 Corporate finance Slide 59 Corporate finance Slide 60 Corporate finance Slide 61 Corporate finance Slide 62 Corporate finance Slide 63 Corporate finance Slide 64 Corporate finance Slide 65 Corporate finance Slide 66 Corporate finance Slide 67 Corporate finance Slide 68 Corporate finance Slide 69 Corporate finance Slide 70 Corporate finance Slide 71 Corporate finance Slide 72 Corporate finance Slide 73 Corporate finance Slide 74 Corporate finance Slide 75 Corporate finance Slide 76 Corporate finance Slide 77 Corporate finance Slide 78 Corporate finance Slide 79 Corporate finance Slide 80 Corporate finance Slide 81 Corporate finance Slide 82 Corporate finance Slide 83 Corporate finance Slide 84 Corporate finance Slide 85 Corporate finance Slide 86 Corporate finance Slide 87 Corporate finance Slide 88 Corporate finance Slide 89 Corporate finance Slide 90 Corporate finance Slide 91 Corporate finance Slide 92 Corporate finance Slide 93 Corporate finance Slide 94 Corporate finance Slide 95 Corporate finance Slide 96 Corporate finance Slide 97 Corporate finance Slide 98 Corporate finance Slide 99 Corporate finance Slide 100 Corporate finance Slide 101 Corporate finance Slide 102 Corporate finance Slide 103 Corporate finance Slide 104 Corporate finance Slide 105 Corporate finance Slide 106 Corporate finance Slide 107 Corporate finance Slide 108 Corporate finance Slide 109 Corporate finance Slide 110 Corporate finance Slide 111 Corporate finance Slide 112 Corporate finance Slide 113 Corporate finance Slide 114 Corporate finance Slide 115 Corporate finance Slide 116 Corporate finance Slide 117 Corporate finance Slide 118 Corporate finance Slide 119 Corporate finance Slide 120 Corporate finance Slide 121 Corporate finance Slide 122 Corporate finance Slide 123 Corporate finance Slide 124 Corporate finance Slide 125 Corporate finance Slide 126 Corporate finance Slide 127 Corporate finance Slide 128 Corporate finance Slide 129 Corporate finance Slide 130 Corporate finance Slide 131 Corporate finance Slide 132 Corporate finance Slide 133 Corporate finance Slide 134 Corporate finance Slide 135 Corporate finance Slide 136 Corporate finance Slide 137 Corporate finance Slide 138 Corporate finance Slide 139 Corporate finance Slide 140
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Corporate finance

  1. 1. CORPORATE FINANCE Ekrem Tufan etufan@yahoo.com 2012-2013 http://etufan.wordpress.com
  2. 2. What will we learn? Week 1: Introduction to corporate finance - What is the finance, corporate finance? -Brief history of managerial finance -The financial manager’s responsibility -The goals of the corporation
  3. 3. What will we learn? Week 2: An overview of managerial finance Week 3: Financial forecasting (Demand and sales forecast) • Questionnaire method • Forecast by using economic indicators relation • International comparison
  4. 4. What will we learn Week 4: Financial forecasting (Demand and sales forecast) continuation… • Income elasticity of demand method • Graphic method • Least squares method • Correlation and regression methods (Please check on your statistics notes) Week 5: Market share calculation Week 6: Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
  5. 5. What will we learn Week 7: Profit planning (Continuation) • Break Even Analysis • Operating Leverage • Financial Leverage Week 8: Working capital management Week 9: Capital budgeting • Payback Period • Net Present Value • Internal Rate of Return • Sensitivity Analysis Week 10:Capital budgeting (Continuation)
  6. 6. What will we learn • Week 11: Student presentations • Week 12: Student presentations
  7. 7. What are we going to acquire? • Learning forecasting of sales (demand). • If you know your future sales, you can make profit planning and know how much fund do you need for working and fixed capital. • Learning how to evaluate and choose the best investment opportunity by applying some methods.
  8. 8. What kind of resources can we use when we doing research? 1. All finance books 2. All articles about finance 3. www.ssrn.com 4. J. Fred Weston and Eugene Brigham,Essentials of Managerial Finance, Harcourt Brace&Company International Edition, 1992 5. Kuhlman Bruce, David W. Wiley and H. Kent Baker, Business Fundamentals, Schweser Institute certificate Program, Publisher: Dearborn Trade, A Kaplan Professional Company, ISBN: 9781419528965 (Electronic book), 2005.
  9. 9. What kind of resources can we use when we doing research? 6. http://en.wikipedia.org/wiki/Demand_foreca sting 7. http://www.angelfire.com/mn3/apse/entles 3.htm 8. Brealey Richard A., Stewart C. Myers and Franklin Allen, Principles of Corporate Finance, The McGraw Hill Companies International edition 2008, ISBN: 978-007- 126327-6
  10. 10. What kind of resources can we use when we doing research? 9. http://etufan.wordpress.com 10.http://en.wikipedia.org/wiki/Demand_foreca sting 11.http://en.wikipedia.org/wiki/Questionnaire_ construction
  11. 11. What is the finance? • Money • Stock exchange • Banks • What else? • How about the companies? • Balance sheet
  12. 12. What is the finance? • To achieve the goals of company; 1. Finding funds from the most suitable sources 2. Using them effectively and 3. Control the results…
  13. 13. An Overview of Managerial Finance • A Short History of Managerial Finance • 1930s: Liabilities and equity • 1940 and 1950s: Assets, quantitative methods, discounted cash flow methods • 1960 and 1970s: Optimization of assets and liabilities and equity, statistical methods • 1980s: Globalization, interest rate and exchange risk • 1990-2000s to today: More risk, more computer, new financial instruments and methods
  14. 14. An Overview of Managerial Finance
  15. 15. An Overview of Managerial Finance • The Financial Manager’s Responsibility • Forecasting and planning • Major investment and control • Coordination and control • Dealing with the financial markets
  16. 16. An Overview of Managerial Finance • The goals of the corporation • Managerial incentives to maximize shareholder wealth • Social responsibility • Stock price maximization and social welfare
  17. 17. Managerial incentives to maximize shareholder wealth •Stockholders •Managers •Make the highest •Having autonomy money from the •Protect themselves from company a hostile takeover or a •Do not want to proxy fightHostile share theirs company takeover.doc Example with others. •Try to maximize stock prices in reasonable level
  18. 18. Social responsibility • Ethical responsibility to provide a safe working environment • To avoid polluting water and air • Produce safe products • But social responsibility has a cost • If the other firms in its industry do not follow suit, their prices and costs will be lower • Most investors do not like to buy socially oriented companies shares.
  19. 19. Stock price maximization and social welfare What requires stock price maximization? 1. Efficient, low-cost plants that produce high- quality goods and services at the lowest possible cost 2. Development of products that consumers want and need, so the profit motive leads to new technology, to new products, and to new jobs Example Example 2
  20. 20. An Overview of Managerial Finance • The Financial Manager’s Responsibility • Forecasting and planning • Major investment and control • Coordination and control • Dealing with the financial markets
  21. 21. Financial forecasting
  22. 22. Some Financial Forecasting Methods • Questionnaire method • Forecast by using economic indicators relation • International comparison • Income elasticity of demand method • Graphic method • Least squares method
  23. 23. Financial forecasting: Questionnaire Simple things: • Quantitative marketing researches and social sciences • Especially, if it is known specific target consumer • By phone, by email, web, go to houses and malls…
  24. 24. Take into consider for questionnaire 1. Determining research aims, example size, duration, human resources, permissions, and privacy before applying questionnaire, 2. Determining natural answers, 3. Questionnaires should be directly related with research’s aims, 4. Applying questionnaire to right participants is very important, 5. Determining questionnaire’s type…
  25. 25. Take into consider for questionnaire • Questions and answers should be neutral, • Ranking and grouping of questions’ should be right, • Questions’ should be basic and non-technical, • No double meaning and negative sentences, • Every question should ask just one subject, • Put “other” option, • Questions’ should be daily communication sentences,
  26. 26. Take into consider for questionnaire • Do not ask private questions, • Carefully use colours, graphics or pictures, • Give numbers to your questions.
  27. 27. An example (This example has been derived from Güvemli Oktay, Yatırım Projelerinin Düzenlenmesi, Değerlendirilmesi ve İzlenmesi, Atlas Kitabevi Yayınları, İstanbul:2008, pp.89-90, ISBN 9789756574065) We would like to search demand of honey consumption of Karvina. We chose an area as example which represents whole Karvina. In this area, there are 200 houses. So we prepared a basic questionnaire and asked questions’ below: 1.Does your family consume honey? 2.If so, how much do you consume per month? 3.How many people live in your family?
  28. 28. An example (Continuation…) Answers: 1.Yes we consume (150 family), No (50 family) 2.500 gram per month 3.4 people If we assume that Karvina’s population is 70.000, the demand could be calculated as:
  29. 29. An example (Continuation…) Family count in Karvina: 70.000/4=17.500 Family Percentage of families who are bought honey= (150 family/200 Family)x100=75% Count of families who are bought honey= 17.500 Family x 75%= 13.125 Family Yearly consumption per family: 500 Gramx12 month=6.000 Gram=6 kg Yearly consumption= 13.125 family x 6 Kg =78.750 Kg.
  30. 30. An example (Continuation…) If Karvina’s population growth rate is +0.41%; We can predict honey consumption: Year Family count Honey buy Yearly consumption family count 2011 17.571 13.178* 79.068** 2012 17.643 13.232 79.392 2013 17.715 13.286 79.716 2014 17.787 13.340 80.040 *(17.571x75%), **(13.178x6kg)
  31. 31. Financial forecasting: Economic indicators relation Finding data which correlated each other for searched sector/subject. Examp: Weather Wheat Bread price Demand estimation using correlated data.
  32. 32. Plasterboard Demand Example (Source: Güvemli Oktay, Yatırım Projelerinin Düzenlenmesi, Değerlendirilmesi ve İzlenmesi, Atlas Kitabevi Yayınları, İstanbul:2008, pp.90, ISBN 9789756574065)
  33. 33. Example (Continuation…) Plasterboard or also called gypsum board are panels made of gypsum plaster pressed between two thick sheets of paper, the panels are used to make interior walls and ceilings. (http://en.wikipedia.org/wiki/Drywall). As Sweet Home Company, we would like to produce and enter plasterboard market in Karvina. Lets calculate demand with using house counts and floor space!
  34. 34. Example (Continuation…) • Internal walls two faces are averagely equal 250 m2 for 100 m2 house while external walls faces are averagely equal 130 m2. There are 20% gaps these walls for windows and doors. • Lets calculate how much wall surface for plasterboard do we have for a 100 m2 houses?
  35. 35. Example (Continuation…) • Internal walls two face surface is equal (250 m2 x 80%) = 200 m2 • External walls two face surface is equal (130 m2 x 80%) = 104 m2 • Whole surface which it can be applied plasterboard is equal (200 + 104 ) 304 m2. We assume that demand for buildings could be 5% for first year and later 7%, 10%, 12% respectively.
  36. 36. Example (Continuation…) It is being predicted new buildings counts which will be built in four years and theirs’ surface is: Years Buildings Surface (m2) 1 160.000 16.000.000 2 175.000 17.500.000 3 190.000 19.000.000 4 210.000 21.000.000
  37. 37. Example (Continuation…) Plasterboard demand: Years Building Estimated plasterboard Plasterboard Counts demanded buildings demand 1 160.000 x (5%) 8.000 *2.432.000 2 175.000 x (7%) 12.250 3.724.000 3 190.000 x (10%) 19.000 5.776.000 4 210.000 x(12%) 25.200 7.660.800 * 1. year demand = 8.000 x 304 m2 = 2.432.000 m2
  38. 38. International comparison This method based on comparing two countries Gross Domestic Product (GDP) per capita and demands which one of them is developed while another developing and assumed that developing country’s demand is going to reach to developed country’s demand in the future . Step 1: Determining developed country’s demand for a specific good and GDP per capita Step 2: Assuming that developing country’s demand will be equall developed country’s demand in the future.
  39. 39. International comparison (Example) Resource: This example has been derived from Güvemli, pp.92. In France, GDP per capita is 30.000€ and orange juice consumption is 15 liter. In Czech Republic GDP per capita is 10.000 € and orange juice consumption is 3 liter. The population is 11.000.000.
  40. 40. Example (Continuation…) Years GDP per capita in Czech Consumption per capita 1 10.000 3 2 15.000 4,5 3 17.000 7,5 4 18.000 9,3 5 22.000 11,2 6 28.000 13,1 7 30.000 15,0 * 7th year data is equal to France current data.
  41. 41. Example (Continuation…) Years Population of Czech (000) Tot. Juice consumption 0 11.000 x 3 liter = 33.000 (Current) 1 11.500 x 3,6 = 41.400 2 11.800 x 4,5 = 53.100 3 12.000 x 7,5 = 90.000 4 12.400 x 9,3 = 115.320 5 12.900 x 11,2 = 144.480 6 13.000 x 13,1 = 170.300 7 13.000 x 15,0 = 195.000
  42. 42. Income elasticity of demand Example: (Güvemli pp.95) Rate of increment of GDP per capita = 3,5% Coefficient of income elasticity of product = 2 Rate of increment of product’s yearly per capita demand = 7% (3,5% x 2) Note: Income elasticity is calculated by dividing rate of increment of demand to rate of increment income.
  43. 43. Income elasticity of demand Example 1: Past periods 2007 2008 2009 Sale of product “A” (Unit) 150.000 180.000 220.000 Yearly rate of increment 20% 22% Average rate of increment ((0,20+0,22)/2) = 21% GDP rate of increment 3,5% 4% 3,6% GDP average rate of increment = (0,035 + 0,04 + 0,036) / 3 = 3,7% Coefficient of income elasticity (21%/3,7%) = 5,6
  44. 44. Income elasticity of demand Demand of product “A”? Next periods 2010 2011 2012 Averg. Predicted GDP rate of increment ((4% + 4,2% + 4,4%)/3)= 4,2% Coefficient of income elasticity = 5,6 Yearly rate of increment= (4,2% x 5,6) = 23,5% Demand of product “A” (2010 period) = 220.000 x 123,5% = 271.700 (2011 period) = 271.700 x 123,5% = 335.550 (2012 period) = 335.550 x 123,5% = 414.404
  45. 45. It is your turn! Question: Dogtas Company is a Turkish company which produces home inner products such as furniture. Dogtas company sold 80.000 furniture in 2007, while 125.000 in 2008 and 100.000 in 2009 respectively. In same period GDP rate of increment was 7%, 9% and 5% respectively. Because World economic crisis, it is being expected GDP rate of increment will be -2% in 2010 while 3% in 2011 and 5% in 2012. So, please calculate Dogtas Company’s furniture demands in 2010, 2011 and 2012.
  46. 46. Graphic method In this method, demand of product and dates are being located on a graphic. Then taking account the numbers density and draw a line. This method is very basic but not reliable.
  47. 47. Graphic method (Example) Date (2009) Demand January 2500 February 2800 March 3050 April 3476 May 3899 June 1257 July 1289 August 3456 September 4900 October 5600 November 7988 December 3678 January 8899 February 7654 March 7889 April 9900 May 6754 June 5678 July 6754 August 7654 September 9876 October 7654 November 7865 December 8888
  48. 48. Least squares method We can use Excel to estimate the demand of our product(s) with applying least squares method.
  49. 49. Least squares method Years Demand Step 1: Open an Excel page and click 1 1250 fx (functions) and chose “Statistics” 2 1578 Step 2: Chose “forecast”. Then you 3 3234 will see three spaces. 4 7500 5 3456 Step 3: For first space chose estimated year (In our examp. 10), for second 6 2200 space chose demand numbers and for 7 4578 third space chose years (In our 8 6543 example from 1 to 9) 9 2134 Step 4: Click to Enter and get the 10 4926 result. Example
  50. 50. How to calculate market share? There are two ways to calculate market share: I. Percentage of sale units: Company’s sale units/Total sale units in the market II. Percentage of income: Total income of the company / Total income of the sector which the company belongs
  51. 51. How to calculate market share? Example: Our company produces cheese in Çanakkale. In 2009 it has produced 70 ton cheese in the city and sold them at 70.000 Euro. In same period our company produced 7 ton cheese and sold it 12.000 Euro. So; Our market share as a unit is: (7 Ton / 70 Ton)x100= 10% Our market share as a sale: (12.000 Euro/70.000 Euro)x100= 17,14%
  52. 52. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
  53. 53. Why should we plan our profit?
  54. 54. Financial managers use profit planning for; • Determine at least how much products should be produced to get profit with using sale and cost information, • Which products should be produced and how much? • Determine the price of the product
  55. 55. What kind of data do we need?
  56. 56. Data • Unit sale price of the product • Sale volume of the product • Sale composition of the products • Unit variable cost • Total fixed costs
  57. 57. Assumptions of profit planning • Costs are divided into two such as fixed and variable but there is one more which is half variable costs • There is only one price and stable • Input prices are fixed • At the end of the financial term, there is no inventory
  58. 58. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
  59. 59. When should we use Break Even Analysis?
  60. 60. We can use Break Even Analysis… • To decide producing a new product and it’s sale volume to get profit • To decide company’s to grow or non-grow situation • To decide to realise modernisation and automation investments • To measure effect of variation of price, fixed and variable costs on profit It can be applied both graphic and mathematics methods...
  61. 61. Limitations Resource: http://en.wikipedia.org/wiki/Break-even_(economics) • Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. • It assumes that fixed costs (FC) are constant. Although this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise. • It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. linearity) • It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period). • In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).
  62. 62. Graphic Method Total Income Income - cost Break even point Profit Total costs loss Amount of production
  63. 63. Continuation... Total costs Break Even Point Loss Income -Cost Break Even Point Total Income Profit Loss Amount of production
  64. 64. Mathematical Method Production level in Break Even Point: Q=F/P-V Sale level in Break Even Point: S=F/1-(V/P) Q: Production level in Break Even Point F: Fixed costs P: Unit price V: Unit variable costs
  65. 65. Break Even Point Assignments Please watch the video and create your own example and send me by email till next lesson. 1.http://www.youtube.com/watch? v=7MxlVMzRxa8&feature=related Break Even Analysis Example Video.xlsx 2.Please done this example by yourself. Print it out and deliver at next lesson. Break event point assignment 2012.xlsx
  66. 66. Example (1) for Break Even Analysis Microsoft Company’s sale is 5.000.000 Euro when production is 20.000 unit, variable costs are 3.000.000 Euro and fixed costs are 1.000.000 Euro. In this case, what is the production level in break even point? Unit price: 5.000.000/20.000=250 Euro Unit variable cost: 3.000.000/20.000=150 Euro Q=1.000.000/250-150 = 10.000 Unit
  67. 67. Example (II) If it is being used same data with first example sale level in break even point=? S=F/1-(V/P) =1.000.000/1-(150/250) =2.500.000 Euro
  68. 68. Different approach to calculate break even point: Additive margin Additive margin = Unit price-Unit variable costs Amount of production in break even point= Total fixed costs/Unit additive margin Additive rate=(Unit price-Unit variable costs) / Unit price Amount of sale in break even point= Total fixed costs/Additive rate
  69. 69. Example III Amount of production in break even point= Total fixed costs/Unit additive margin Unit additive margin = 250-150 = 100 Amount of production in break even point = 1.000.000/100 = 10.000 unit
  70. 70. Continuation…. Additive rate=Unit price-Unit variable cost/Unit price Sales in break even point= Total fixed costs/additive rate = 1.000.000/(250-150/250) = 2.500.000 Euro
  71. 71. Break even point and target profit Amount of production in break even point which is being taken consider target profit= (Fixed costs + EBIT)/(Unit price-Unit variable cost) The company is targeting 2.000.000 Euro profit. So, what is the amount of production in break even point =(1.000.000+2.000.000)/(250-150) Additive rate = 30.000 Unit How about break event point in sale?
  72. 72. Example IV • Dardanel A.Ş. Produce Tuna fish (500 gram) and sell it 50 Euro per can. Other informations are given below: • Direct raw materials and consumables cost: 12.5 Euro/can • Direct labour costs: 8.25 Euro/can • Variable production overheads: 3.75 Euro/can • Fixed production overheads : 425.000 Euro • Fixed marketing costs: 150.000 Euro a) How many Tuna fish can should be produced to get break even point? b) How much sales should be achieved to get break even point? c) The boss Mr. Niyazi Önen would like to make 400.000 Euro profit. In this case, how many can should be sold?
  73. 73. Continuation… a) BEPQ= Fixed costs/(Unit sales price-Unit variable cost) • Unit varible cost=Direct raw material cost+Direct labour cost+ Variable production overheads • Unit variable cost = 12.5+8.25+3.75 = 24.5 • BEPQ= (425.000+150.000) /(50-24.5) • BEPQ= 22.549 Unit
  74. 74. Continuation… b) BEPS=Fixed costs/(1-(V/P) BEPS= 575.000 /(1-(24.5/50) BEPS= 1.127.450 Euro c) BEPQ= (425.000+150.000+400.000) /(50-24.5) BEPQ= 38.235 Tuna fish can
  75. 75. Multiproduct Break Even Point Source: Tsorakidis Nikolaos, Sophocles Papadoulos, Christopher Zerres and Michael Zerres, Break Even Analysis, 2008, www.bookboon.com, ISBN 978-87-7681-290-4 Example: Quick Coffee, a cafeteria that sells three types of hot drinks: White/Black coffee, espresso and hot chocolate.
  76. 76. Continuation…
  77. 77. Continuation… Quick cafe breaks even when it sells 19,784 hot drinks in total. To determine how many units of each product it must sell to break even we multiply the break-even value with the ratio of each product’s revenue to total revenues. Classic coffee: 19.784 x 50% = 9.892 Unit Espresso: 19.784 x 30% = 5.935 Unit Hot chocolate: 19.784 x 20% = 3.957 Unit
  78. 78. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
  79. 79. When should we use Operating Leverage?
  80. 80. We can use operating leverage… • To search how much fixed and variable costs can be accepted by using relationship between them • To estimate extra productions effect on profit when production exceeds a certain level • To decide if a company based on labour force or capital
  81. 81. Operating Leverage Formulas Pr ofit variability ( %) OP = Sales variability (%) or ∆EBIT OP = EBIT ∆SALES SALES
  82. 82. Operating Leverage Formulas Sales − Variable Costs OL = EBIT
  83. 83. Example Student Agency Company’s variable costs are 3.000.000 € at 5.000.000 € sales level. EBIT is 1.000.000 €. If we assume that sales can be increased 10%, EBIT will be 1.200.000 €. So, (1.200.000 − 1.000.000) / 1.000.000 OP = =2 (5.500.000 − 5.000.000) / 5.000.000 This means, profit will increase 2 € if sales increase 1 € at 5.000.000 € sales level.
  84. 84. Example Sales − Variable Costs OL = EBIT 5.000.000 − 3.000.000 OL = =2 1.000.000
  85. 85. Lets check the result… Current situation New situation % Sales 5.000.000 € 5.500.000 € 10 Variable costs 3.000.000 € 3.300.000 € 10 Fixed costs 1.000.000 € 1.000.000 € 0 Total Costs 4.000.000 € 4.300.000 € 7.5 EBIT 1.000.000 € 1.200.000 € 20 Pr ofit variability ( %) 20% OP = = =2 Sales variability (%) 10%
  86. 86. Example Source: Tsorakidis Nikolaos, Sophocles Papadoulos, Christopher Zerres and Michael Zerres, Break Even Analysis, 2008, www.bookboon.com, ISBN 978-87-7681-290-4, pp.14-16.
  87. 87. Continuation… For sales volume from 50.000 to 60.000 OP of ∆EBIT EBIT First Company = OP = ∆SALES SALES OP = ((90-70)/70)) / ((240-200)/200) OP = 1,43 (approximately)
  88. 88. It’s your turn…
  89. 89. It’s your turn…
  90. 90. Continuation… OP 1= 1.43 OP 2= 1.65 OP 3= 1.67 If sales could be increased 10%, its profit will increase; • 14.3% for company 1 • 16.5% for company 2 • 16.7% for company 3 What happens if sales decrease in same level?
  91. 91. Continuation… • Which company reach first its break even point? Why? • Please calculate it and make critics! • Answer: First one reaches at 15.000 Units while the others 20.000 Units. Because, first company has the lowest fixed costs, even has the highest unit variable cost. • The larger the degree of operating leverage, the greater the profits volatility.
  92. 92. Continuation… Company Unit sale price (€) Unit variable cost (€) Fixed costs (€) Company 1 4 2 30.000 Company 2 4 1.5 50.000 Company 3 4 1 60.000
  93. 93. Profit planning • Break Even Analysis • Operating Leverage • Financial Leverage
  94. 94. Financial Leverage http://www.investorwords.com/1952/financial_leverage.html • The degree to which an investor or business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may also be unable to find new lenders in the future. • Financial leverage is not always bad, however; it can increase the shareholder’s return on investment and often there are tax advantages associated with borrowing.
  95. 95. When should we use Financial Leverage?
  96. 96. We can use financial leverage… To search a company’s debts effect on it’s profit.
  97. 97. Financial leverage formulas EBIT FL = EBIT − C C = Inreterest cost Profit increase per share FL = Profit increase ∆profit per share profit per share FL = ∆EBIT EBIT
  98. 98. Example Student Agency Company’s capital is 20.000.000 €, total debts are 10.000.000 €. Debts are 8% interest rate bank loans. EBIT is 15.000.000 €. The company has a chance to increase it’s EBIT 20%. Please calculate financial leverage of the company and make comments on the result.
  99. 99. Example Interest cost = 10.000.000 € x 8% = 800.000 € EBIT 15.000.000 FL = = = 1.05 EBIT − C 15.000.000 − 800.000 C = Inreterest cost 1.05x20%=0.21 If the company can increase it’s EBIT 20%, earnings per share (EPS) also will increase 21%. What happens if we get 20.000.000 € credit at same cost, how it effects on EPS and risk? Answer: 20.000.000 x 8% = 1.600.000 FL= 1.11 So, 1.11x20%= 0.22
  100. 100. Financial leverage If the company use infinite debt does this mean earnings per share will be also infinite? If not why? We are in an economic crises. So, what do you think our company’s situation if we compare other one (1.5) in our example? Answer: If another company’s financial leverage is 1.5 this means our company has less risk but EPS will increase 30%.
  101. 101. WORKING CAPITAL MANAGEMENT
  102. 102. Working capital terminology Working capital (gross working capital): Current assets Net working capital: Current assets – current liabilities
  103. 103. Working capital: Peddler example
  104. 104. The conversion cycle Real Time Computer Corporation (RTC), which in early 1992 introduced a new super minicomputer that can perform 15 million instructions per second and that will sell for $250.000. The effects of this new product on RTC’s working capital position were analyzed in terms of the following five steps:
  105. 105. Resource: J. Fred Weston and Eugene Brigham,Essentials of Managerial Finance, Harcourt Brace&Company International Edition, 1992.pp.364.
  106. 106. Continuation… 1. RTC will order and receive the materials it needs to produce the 100 computers that are expected to be sold. Because RTC and most other firms purchase materials on credit, this transaction will create an account payable. However, the purchase will have no immediate cash flow effect.
  107. 107. Continuation… 2. Labor will be used to convert the materials into finished computers. However, wages will not be fully paid at the time the work is done, so accrued wages will build up. 3. The finished computers will be sold but on credit, so sales will create receivables, not immediate cash inflows.
  108. 108. Continuation… 4. At some point during the cycle, RTC must pay off its accounts payable and accrued wages. Because these payments will be made before RTC has collected cash from its receivables, a net cash outflow will occur, and this outflow must be financed. 5. The cycle will be completed when RTC’s receivables have been collected. At that time, the company will be in a position to pay off the credit that was used to finance production, and it can then repat the cycle.
  109. 109. Cash conversion cycle model Inventory conversion period (ICP): It is the average length of time required to convert materials into finished goods then sell those goods. Inventory conversion period= Inventory / Sales per day For example: If average inventories are $2 million and sales are $10 million; ICP=$2.000.000/($10.000.000/360) = 72 days
  110. 110. Continuation… Receivables collection period (RCP): It is the average length of time required to convert the firm’s receivables into cash, that is, to collect cash following a sale. RCP= Receivables / (sales/360) If receivables are $666,667 and sales $10 million, RCP= $666,667 / ($10,000,000/360)= 24 Days
  111. 111. Continuation… Payables deferral period (PDP): It is the average length of the time between the purchase of materials and labour and the payment of cash for them. PDP= Payables/ Credit purchases per day = Payables/ (cost of goods sold /360) If the firm on average has 30 days to pay for labour and materials, if its cost of goods sold are $8 million per year, and if accounts payable average $666,667; PDP= $666,667 / ($8,000,000/360) = 30 days
  112. 112. Continuation… Cash conversion cycle (CCC): It nets out the periods just defined and which therefore equals the length of time between the firm’s actual cash expenditures to pay for productive resources (labour and materials) and its own cash receipts from the sale of products. CCP= Inventory conversion period + receivables collection period - payables deferral period
  113. 113. Continuation… CCP= Inventory conversion period + receivables collection period - payables deferral period CCP= 72 days + 24 days – 30 days CCP= 66 days
  114. 114. Result With calculating and finding 66 days, RTC knows when it starts producing a computer that it will have to finance the manufacturing costs for a 66 day period. The firm’s goal should be to shorten its cash conversion cycle as much as possible without hurting operations.
  115. 115. It is your turn! Dardanel A.Ş. Produces frozen and canned food such as sea fishes, octopus and mussel. The company will produce new product namely blue fish which lives only in Istanbul Bosporus and Canada. So the product is very valuable and expensive. It has also market in Europe. A canned food be produced in 20 minutes and work hours are 8 hours per day. Marketing department says 90% of the production will be sold .The price will be 10 Euros per canned food. Average inventories are 8.000 Euro. (330 working days assumed but year 360 days.
  116. 116. Continuation… Other things related with sales: • Labour get salary 30 days after the work • Payments for raw material are done 45 days later • 80% of sales are done cash while 20% of sales are credit. • Cost of goods are sold is 28.800 Euro • Accounts payable is 12.200 Euro Please calculate effects of this new product on Dardanel Company’s working capital position.
  117. 117. CAPITAL BUDGETING (Strategic Long term Investment Decision)
  118. 118. Capital budgeting (Strategic Long-Term Investment Decisions) • Generating ideas for capital projects • Who creates the capital budgeting projects? • Do we need to be an entrepreneur? • Two questions for testing being entrepreneur (CV and address book)
  119. 119. Strategic Long-Term Investment Decisions • Project classifications 1. Replacement: Maintenance of business 2. Replacement: Cost reduction 3. Expansion of existing products or markets 4. Expansion into new products or markets 5. Safety and/or environmental projects 6. Other
  120. 120. Project classifications • Replacement: Maintenance of business • One category consists of expenditures to replace worn-out or damaged equipment used in the production of profitable products. • Should we continue to produce these products or services? • Should we continue to use our existing production processes?
  121. 121. Project classifications • Replacement: Cost reduction • This category includes expenditures to replace serviceable but obsolete equipment. • The purpose here is to lower the costs of labour, materials, or other inputs such as electricity.
  122. 122. Project classifications • Expansion of existing products or markets • Expenditures to increase output of existing products, or to expand outlets or distribution facilities in markets now being served are included here.
  123. 123. Project classifications • Expansion into new products or markets • These are expenditures necessary to produce a new product or to expand into a geographic area not currently being served.
  124. 124. Project classifications • Safety and/or environmental projects • Expenditures necessary to comply with government orders, labour agreements, or insurance policy terms fall into this category.
  125. 125. Project classifications • Other project investments • This catch all includes office buildings, parking lots, executive aircraft, and so on.
  126. 126. Strategic Long-Term Investment Decisions • Similarities between capital budgeting evaluation techniques 1. Project cost 2. Expected cash flows estimation 3. Estimation of project riskiness 4. Cost of capital decision 5. Measurement of present value of cash inflows 6. Present value of the expected cash inflows and required outlay
  127. 127. Capital Budgeting Evaluation Techniques 1. Payback Period 2. Net Present Value (NPV) 3. Internal Rate of Return (IRR) 4. Sensitivity Analysis
  128. 128. Capital Budgeting Evaluation Techniques • Payback period • Project S : Net Cash Flow Cumulative NCF
  129. 129. Payback period • Project (S) Uncovered cost at start of year Payback=Year before full recovery + Cash flow during year 100 Payback Period (S)= 2 + = 2,333 Years 300
  130. 130. Capital Budgeting Evaluation Techniques • Payback period • Project L : • Net Cash Flow • Cumulative NCF
  131. 131. Payback period • Project (L) 200 Payback Period (L)= 3 + = 3,333 Years 600
  132. 132. Net Present Value (NPV) • To implement this method, it should be proceeded as follows: • Find the present value of investment and its future cash flows with discounting at the project’s cost of capital • Sum discounted investment and cash flows • If the NPV is positive then we accept the project. If we have to choose a project among the alternate projects, we should take into consider the highest NPV
  133. 133. Net Present Value (NPV) CF1 CF2 CFn NPV = CF0 + 1 + 2 + ..............+ n (1+ k ) (1+ k ) (1+ k ) n CFt =∑ t =0 (1 + k ) t
  134. 134. Capital Budgeting Evaluation Techniques • Internal rate of return (IRR) • The IRR is defined as that discount rate which equates the present value of a project’s expected cash inflows to the present value of its expected costs.
  135. 135. Internal rate of return (IRR) CF1 CF2 CFn CF0 + 1 + 2 + ..............+ n =0 (1+ IRR ) (1+ IRR ) (1+ IRR ) n CFt =∑ =0 t =0 (1 + IRR ) t
  136. 136. Example of NPV, IRR and Sensitivity • Small Scale Flower Cultivation Project in India • This project has written by Weitz Center (Israel) experts for an area in India. • The project covers an area about one acre. The aim is producing and selling flowers. Project’s cost will be covered by a bank loan. All costs and sale data have been collected and realised that target sales could be achieved. Cost benefit analysis Flower.xls
  137. 137. Sensitivity Analysis Example
  138. 138. Contuniation…
  139. 139. Contuniation… (The data pasted as collateral. It should be one under the other.)
  140. 140. Thanks for your patience…
  • HiepNguyen1

    Sep. 1, 2013
  • kubioz

    Dec. 5, 2012

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