Look homework ch1 Q 28 on GP,

Chapter 2
Business cycles refer to the rise and fall of economic activity relative to its long-
term growth trend. Macroeconomics is the study of the economy as a
whole(national income, unemployment, inflation). Microeconomics studies
consumers, producer, and supplier.
The most common measure of the economic activity or output of an economy is
GDP
GDP includes all final good and services produced by resources within a country
regardless who owns the resources. Foreign company produce output in USA is GDP.
Nominal GDP(unadjusted) measures the value of all final goods and services in
prices prevailing at the time of production. Real GDP is adjusted changes in price
level.
Expansionary phase -> peck -> contractionary phase -> trough -> recovery phase
Recession occurs when the economy experiences negative real economic growth
and depression is long period of recession. Recession is defined as a period of falling
GDP so it can be caused by a decrease in A/S and decrease in A/D.
Leading indicators(before),lagging indicators(after),coincident indicator(during)
Multiplier effect: 1 dollar increase in government spending results in a greater than
1 increase in real GDP.
Economic measures: 1)unemployment 2)inflation 3)interest rate 4)real GDP
Two methods of measuring GDP: expenditure approach and income approach
Expenditure approach: GICE. Government purchase of good and service, Gross
private domestic investment, Personal consumption expenditures, Net exports
Income approach: IPIRATED. Income of proprietors, Profits of corporations, Interest,
Rental income, Adjustments of rent foreign income and miscellaneous items, Taxes,
Employee compensation, Depreciation.
Discount rate set by the federal reserve is the rate that the central bank charges for
loans to commercial banks.
Real interest rate= nominal interest – inflation rate
Inflation rate= ((cpi this period-cpi last period) / cpi last period) *100
Inflation rate measures the rate at which the overall price level increases.
Stagflation occurs when the economy suffers a recession that is characterized by falling output,
rising unemployment, and a rising price level.
The consumer price index measures the costs of a market basket of specific goods commonly
purchased by consumers. It measures consumer buying power and is not distorted by items
generally bought by industry.
GNP differs from GDP b/c GNP includes goods and service that are produced
overseas by U.S. firms.
Frictional unemployment: rotate job. Structural unemployment: not correspond skill,
don’t live where job is located. Seasonal unemployment: increase demand labor on
Christmas. Cyclical unemployment: resulting from declines in real GDP.
Full employment is no cyclical unemployment. Normal rate of unemployment
is adding all frictional, structural and seasonal unemployment.
Real GDP per capita is real GDP divided by population. Real GDP per capita is typically used
to compare standards of living across countries or across time. By dividing real GDP by
population, this measure adjusts for differences in the size of countries and for differences in
population over time.
CPI is a measure of the overall cost of a fixed basket of goods and service
purchased by an average household.
An increase in nominal wages represents an increase in input cost which will sift
supply curve to left.
Change in quantity demanded is a change in the amount of a good demanded
resulting solely from a change in price.
Change in demand is a change in the amount of a good demanded resulting from
a change in something other than the price of the good.
Change in quantity supplied is a change in the amount producers are willing and
able to produce resulting solely from a change in price.
Change in supply is a change in the amount of a good supplied resulting from a
change in something other than the price of the good.
Most to least competitive to least competitive: 1) perfect competition
2)monopolistic competition 3)oligopoly 4)monopoly
Under monopolistic competition, strategic plans include maintaining the market share (as with
pure competition), but they also likely include plans for enhanced product differentiation and
allocation of resources to advertising, product research, etc.
Any business firm that has the ability to control the price of the product it sells faces a
downward-sloping(oligopoly) demand curve for the firm. Only the firm in a competitive market is
a price-taker facing a horizontal demand curve(price taker) at the market equilibrium price.
Perfect(pure) competition: very competitive like selling bottled water. Price taker:
you take whatever you can get. Maintaining the market share and being responsive
to market conditions related to sales price.
Monopolistic competition: maintaining the market share and planning for enhanced
product differentiation.
Oligopoly: maintaining the market share, ensuring product differentiation, and
adapting to price changes or required changes in production volume.
Monopoly: price settler. You are the only seller so can set the price. Profitability from
production levels that maximize profits.
Review the handout
Inelastic: increase in price will result in an increase in total revenue.(demand<1.0)
Elastic: increase in price will result in an decrease in total revenue.(demand>1.0)
Unit elastic: increase in price will have no effect on total revenue(demand = 1.0)
Factors that affect the competitive environment of the firm: 1) barriers to market
entry 2) market competitiveness 3) existence of substitute products 4) bargaining
power of the customers 5) bargaining power of the suppliers
Price ceilings is a price that is established below the equilibrium price, which causes
shortages to develop
Price floors is a minimum price set above the equilibrium price, which causes
surpluses to develop.
Two major categories of business activities: 1) primary activities 2) support
activities.
Primary activities is advertising, deliver good, warranty
Support activities is procurement of material
Three major types of strategic frameworks that have been proven to be useful for
value chain analysis are industry structure analysis, core competencies analysis,
and segmentation analysis.
Vertical integration: firm may desire to improve its competitive advantage through
merge with supplier.
Transaction exposure: organization could suffer economic loss or gain upon result of
changes in the exchange rates.
Economic exposure: organization’s cash flows could increase or decrease as a result
of changes in the exchange rates.
Translation exposure: foreign subsidiaries will change as a result of changes in the
exchange rates when conversion of foreign f/s to u.s. $
Hedging is how we protect ourselves against the exchange rate moving in our
direction or against us.
Futures hedge: for A/P we can have futures hedge contract to buy the foreign
currency. For A/R we can have future hedge contract to sell the foreign currency.
Forward hedge: same as future hedge but must larger amount.
Money market hedge: uses international money markets to plan to meet future
currency requirements. Uses domestic currency to purchase a foreign currency at
current spot rates and invest them in securities timed to mature at the same time
as related payables.
Good example for money market hedge on p. 78
Transfer pricing: claim profits in country with lowest tax rate.
Chapter 3
Risk-indifferent behavior: certainty = expected return
Risk-averse behavior: certainty < expected return
Risk-seeking behavior: certainty > expected return
Diversification: reduce risk by mixing investment on different way.
Diversifiable Risk: non-market, unsystematic, not related to market DU NS
Nondiversifiable Risk: market or systematic risk, related to marketcannot
eliminate
Stated interest rate is the rate wrote on the contract. Effective interest rate is the
real interest rate you are paying after deducting fees.
Ex> borrow 100,000 from bank. Stated rate 9%. What is effective interest rate in
discounted note? Answer> discounted note is the note you pay interest in front
when you get the money. So 100,000*9%=9000(need to pay first). So you are
getting 100,000-9000=91,000. effective interest rate is 9000/91000=9.89%
Leverage is amplifies(확대) risk and potential return
Operating leverage: fixed or variable. Fixed is risk taker, pay people by salary.
Variable is not a risk taker, pay people by commission
DOL = percentage change in EBIT(Earnings Before Interest and Taxes)
percentage change in sale
Financial leverage: fixed or variable. Fixed: borrow money so risk and return goes
up. Variable: adding partner and SH so risk and return goes down.
DFL = percentage change in EPS
percentage change in EBIT
combined (total) leverage;
DCL = percentage change in EPS
Percentage change in sales

DOL DFL DCL

% ㅿ in EBIT % ㅿ in EPS % ㅿ in EPS
% ㅿ in Sales % ㅿ in EBIT % ㅿ in Sales
People are only going to use leverage if they are willing to assume risk. Firms and
people will not employee leverage when they are risk-averse.
Financial leverage increase when the debt to equity ratio increase.
Implications of leverage: are sales stable and high enough to cover high fixed cost?
Then you should use leverage, it will enhance the return to the owner.
Optimal capital structure is that mix of financing instruments that produces the
lowest WACC. The mixture of debt and equity(A=L+E) securities that produce the
lowest WACC maximizes the value of the firm(net worth). WACC is computed by
multiplying the required returns on equity and debt by the percentage of equity and
debt used to finance that particular project.
Manager must invest capital in projects that will get a return greater than
WACC(hurdle rate). WACC is good for the investment which company is already
investing in. WACC is not proper to use for different project unless carry same
risk. b/c different projest has different risk.
The lower the cost of capital, the higher the return. Debt carries the lowest cost of
capital and is tax deductible. The higher the tax rate, the more incentive exists to
use debt financing. Debt(KDX)(always after tax) is the cheapest way to raise
capital b/c bondholder assume less risk and interest is tax deductible.
Preferred stock(KPS): more expensive than debt b/c PS assume more risk than
bondholder(debt) and dividend is not tax deductible. When company bankruptcy,
company will pay fist to bondholder (debt) and P/S and last to C/S.
Preferred stock dividends represent the finance charge to the company for raising
capital with preferred stock.
Cost of retained earnings(KRE): most expensive source of capital b/c C/S assume
most risk and their returns after bondholder and P/S and no tax deductible.
CAPM = risk free rate(treasury bond) + [beta(market rate – risk free rate)]
Cost of long tern debt: fixed return, tax benefit
Cost of preferred stock: fixed return, no tax benefit
Cost of retained earnings: no fixed return, no tax benefit, growth relates to
corporate and industry performance
Cost of capital considers the cost of all funds whether they are short, long term, new
or old.
Debt Equity
Flexibility No Yes
Tax Deductibility Yes No
EPS Dilution No Yes
Increased Risk Yes No
Cost Low High
Return Fixed Variable
ROI is return on investment
ROI = income / Investment Capital
OR
ROI = Profit Margin (or Return on Sale) * Investment Turnover

Net book value (equity)

* Hurdle rate (CAPM)
=required return NI – required return = residual income
Residual income is the income earned more than required income(hurdle rate).
Residual income is the segment margin of an investment center after deducting the
imputed interest (hurdle rate) on the assets used by the investment center. Residual
income is defined as income(no cash flow b/c it use accrual method) in excess of a
desired minimum return. Historical weighted average cost of capital is usually used
as the target or hurdle rate in the residual income approach.
Return on asset could be manipulated. You don’t buy any new assets, you keep
using the old stuff as long as you can. It’s a disincentive to invest. But residual
income though, focuses the manager on simply getting a return above a hurdle
rate. They don’t have to worry about buying more assets and replacing old
equipment. They’ll want to do that so long as they can earn a rate of return above
and beyond the hurdle rate. ROI may lead to rejecting projects that yield positive
cash flows.
The net cost of debt is computed as the effective interest rate net of tax. No coupon
rate used. So if effective rate is 14% and tax is 30%, then .14*.7=9.8%
Problem> A company operating income 500, total asset 1000. B company OI 400,
TA 1600. required rate of return is 10%. What is residual income?
Division Operating Income Total Assets x Required Rate = Residual income

A $500 $1,000 x .10 = $100 $400

B $400 $1,600 x .10 = $160 $240

Total $900 $260 $640

The goal of working capital management is shareholder wealth maximization.
WC=CA-CL High WC (high CA low CL),
CR= CA / CL QR= (cash + marketable securities + receivable) / CL
The quick ratio is a more rigorous(엄격한) test of liquidity than the CR, inventory and
prepaids are excluded.
If WC decrease then Risk goes up and expected return goes up.
Transaction motive (pay bill for ordinary course of business), speculative motive
(cash on hand to make advantage of cheap investment), precautionary motive
(holding cash to maintain safety)
Increasing cash level: speeding up cash inflow and slowing down cash outflows.
Cost of quick payment discount formula:
360 * Discount
Pay period – discount period * 100%-Discount %
Cash conversion cycle(shorter better)
CCC= inventory conversion period + receivables collection period – payable deferral period

Inventory conversion period = average inventory / average cost of sales per day
Receivables collection period = days sales outstanding = average receivables / average sales per day

Payables deferral period = average payables / average purchases per day

Reorder point = safety stock + (lead time for receiving stock * # of sale during lead
time)
Economic order quantity will tell you how much to order and how often to order. It
assumes that demand is known and is constant throughout the year, does not
consider stockout costs, nor does it account for costs of safety stock. Also assumes
that order cost is fixed and that carrying costs include storage, obsolescence,
materials, insurance and interest.
E= square root of (2SO/C) S: annual sales O: cost per Order C: carrying cost per unit

JIT(just in time): 1. lot size equal to one 2. insignificant set up times and costs 3.
balanced and level workloads 4. pull through system. JIT inventory model were
developed to reduce the lag time between inventory arrival and inventory use.
Minimize total inventory cost: EOQ
Chapter 4
Hash total and echo check is used for detective.

DDS: interactive system

Stakeholder: anyone in the organization who has a role in creating or using the
documents and data stored on the computers or networks.
Database administrator: design and control database, assignment of user code.
Data administrator: definition and control of data.
System analysts and application programmer can be same person but system
programmer and application programmer should not be same person.
Advantage of database management system (DBMS): reduced data redundancy and
inconsistencies, ability to expand data fields without affecting application programs
and data accessibility increases the timeliness, effectiveness, and availability of
information.
Disadvantage of DBMS: need highly trained personnel, expensive, increased
chances of breakdowns, possible obscuring of the audit trail and specialized backup
and recovery procedures required.
Gateways connect different types of networks, and routers route packets of data
through interconnected LANs.
Three-tier architecture is desktop client, application and database.
A firewall prevents unauthorized users and isolates a private network of some type
from a public network. It also maintains a connection between those two networks.
Disaster recovery plan should include backup and downtime(가동시간) controls.
B2B can happen through internet, EDI, intranets or extranets.
Mapping is the process used to determine which elements in the entity’s computer
system correspond to the standard data elements.
Benefit of using electronic funds transfer (EFT); reduction of the frequency of data
entry errors but not improvement of the audit trail for cash receipts and
disbursements.
Data mining: use for in order to attempt to discover hidden patterns and trends in
historical business activities and help mangers understand the change and decision
supp.
Job control language: computer operating system performs scheduling, resource
allocation, and data retrieval function based on a set of instruction.
Analysis  design  programming  testing  implementation
Hot site: location that is equipped with a redundant hardware and software
configuration but now location where a company can install data processing
equipment on short notice.
When changing from manual system to computer system: only implementing
controls change, however, internal control principles, objectives does not change.

Chapter 5
Break-even analysis assumes that over the relevant rage: total FC same but FC per
unit change, VC per unit same but total VC change.
Flexible budget: provides budgeted numbers for various activity levels.
Benchmarking would be used by a company in comparing its financial data to
published information to determine if optimal. Benchmarking is the process often
used to identify standards that define or quantify critical success factors.

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