1. Introduction Financial statements
Chapter I & II Tutorial
Introduction
Financial statements

2. Role and Environment of Managerial Finance
Finance and its major areas and opportunities
Managerial finance function and its relationship to economics and accounting
Primary activities of financial manager
Goal of the firm, corporate governance, role of ethics and agency issue
Financial institutions and markets
Business taxes and their importance in financial decisions

3. Critical Thinking Starbucks case: foreign expansion
Possible issues for CFO: Currency risk
What additional concerns might a CFO face when a company expands into international markets?

4. Exercise 1 - 2
You are a treasurer at AIMCO, who develops technology for video conferencing
Manager of a division asks you to authorize a capital expenditure of $10,000
The funds are for a project on which $2,5 million had been spent over the past years
He admits though that the technology concept developed has been surpassed
Use marginal cost-benefit analysis

5. Example Solution
Sunk costs – ignored by marginal benefit analysis = $2,5m are irrelevant
Will the $10,000 additional investment generate a revenue exceeding $10,000?
Compare to other possible projects
Competitors, industry, new technology

6. Exercise 1 - 3 The end of the year party
The treasurer’s staff contends that the firm is running low on cash and might have trouble paying its bills.
The controller’s staff disagrees as the firm continues to be very profitable.
Can both sides be right?

7. Exercise 1 - 3 Solution Cash Flow vs. Accrued Profits
Expenses have shorter due date than expected revenues
Short term financing
Cash crunch, company experience, employee morale

8. Exercise 1 - 4
Some branches of Donut Shop, Inc., have dropped the practice of allowing employees to accept tips.
You notice that the lines are longer and more mistakes are being made in your order.
Why tips can be viewed as stock options and incorrect orders could represent a case of agency cost?
If tips are gone, how can they reduce these agency costs?

9. Exercise Solution
Agency costs - incurred by stockholders to ensure against dishonest acts and to give incentives to management
Banning tips reduced performance
Profit sharing plan
Unnecessary backlash

10. Problem 1 - 2 Marginal cost benefit analysis
Benefits from new robotics $560,000
Benefits from old robotics $400,000
Cost of new equipment $220,000
Sale of old equipment $70,000
Calculate marginal benefits, costs, net benefit.
What do you recommend that the company do? Why?
What other factors should you consider?

11. Problem 1 - 2 Solution Marginal benefits = 560,000 - 400,000 = 160,000
Marginal cost = 220, ,000 = 150,000
Net benefits = MB - MC = 10,000
Net benefit positive = recommend replacement
Consider timing, cash flow and risk

12. Problem 1 - 3 Accrual income versus cash flow
Value of books shipped $760,000
Collected in cash $690,000
Cost of books $300,000
Using accrual accounting show the firm’s net profit
Using cash accounting show the firm’s net cash flow
Which of the statements is more useful to the financial manager and why?

13. Problem Solution
Net profit = Sales - Cost of goods sold = 760, ,000 = 460,000
Net cash flow = Cash receipts - Cost of goods sold = 690, ,000 = 390,000
Cash flow statement is more useful to financial manager

14. Problem 1 - 4 Identifying agency problems, costs and resolutions
The front desk receptionist routinely takes an extra 20 minutes of lunch to run personal errands.
Division managers are padding cost estimates so as to show short-term efficiency gains when the costs come in lower than the estimates.

15. Problem 1 - 4 Solution Employee compensated for unproductive time
Installing time clock
Opportunity costs. Money budgeted to cover inflated costs is not available for other projects.
Base reward system on how close the estimates are.

16. Problem cont…
The firm’s CEO has secret talks with a competitor about the possibility of a merger in which (s)he would become a CEO of the combined firm.
A branch manager lays off experienced full-time employees and staffs customer service positions with part-time workers to lower costs and raise profit. His bonus is based on profitability.

17. Problem 1 - 4 Solution cont…
The CEO may negotiate a deal favoring the buyer.
Open the firm up for purchase bids.
Part time workers are generally not as productive as full-time employees.
Implementing stock incentive plan.

18. Problem 1 - 5 Corporate Taxes EBIT = $92,500 $75,000 to $100,000
Base tax 13, % * amount over $75,000
Calculate firm’s tax liability.
How much are after tax earnings?
What was the firm’s average tax rate?
What was the firm’s marginal tax rate?

19. Problem 1 - 5 Solution Total taxes due
13,750+[0.34*(92,500-75,000)]
13,750+5,950 = 19,700
After tax earnings: 92, ,700 = 72,800
Average tax rate: 19,700 / 92,500 = 21,3%
Marginal tax rate: 34%

20. Financial Statements Balance sheet Income statement Cash flow
Statement of retained earnings
Statement of stockholders equity

21. Balance Sheet Assets Liabilities Cash Accounts payable
Accounts receivable
Inventories
Land and buildings
Machinery and equipment
Other
Accumulated depreciation
Liabilities
Accounts payable
Accruals
Long-term debt
Stockholder’s equity
Retained earnings

22. Income Statement Revenue Expense Sales revenue Interest income
Irregular income
Expense
Cost of goods sold
Operating expenses
Depreciation expense
Interest expense

23. Cash Flow
Analyses the firm’s ability to generate cash and cash equivalents
Direct and Indirect method to calculate
Statement of CF shows:
Where did the cash come from?
What was it used for?
What was the change in the cash balance?
Operating, Investing and Financing activities
Sources vs. Usage of funds

24. Problem 2 - 1
See book

25. Problem 2 - 2
See book