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What-if Questions
Companies have developed a number of ways of asking what-if questions
What if your market share turns out to be higher or lower than you forecast?
So
Uncertainty means that more things CAN HAPPEN than
WILL HAPPEN.
managers are given a forecast, they try to what else might happen implications of those events. This is called SENSITIVITY ANALYSIS.
DEPRECIATION
What is true depreciation? It is the amount that the firm must reinvest simply to offset any deterioration in its assets. The purpose of depreciation is to allocate the original cost of the asset over its life, and the rules governing the depreciation of asset values do not reflect actual loss of market value. As a result, the book value of fixed assets often is much higher than the market value, but often it is less.
CASH FLOWS
THE MOVEMENT OF MONEY INTO AND OUT OF A BUSINESS
But since cash flows rarely proceed as anticipated, companies constantly need to modify their operations. If cash flows are better than anticipated, the project may be expanded;
Case Study
PROBLEM STATEMENT:
A project currently generates sales of $10 million, variable costs equal to 50 percent of sales, and fixed costs of $2 million. The firms tax rate is 35 percent. What are the effects of the following changes on after-tax profits and cash flow?
a) SALES INCREASE FROM $10 MILLION TO $11 MILLION.
b) VARIABLE COSTS INCREASE TO 60 PERCENT OF SALES.
REFERENCE: FUNDAMENTALS OF CORPORATE FINANCE THIRD EDITION RICHARD A. BREALEY CAHPATER 6 PROBLEM 4
Profits
To Vary: 1. Overall Sales 2. Variable Costs Conclude their results on OBJECTIVE FUNCTION
Assumptions
To keep the example simple we have assumed
I.
NO INFLATION
II. We Have Also Assumed That The Entire Investment Can Be DEPRECIATED STRAIGHT-LINE FOR TAX PURPOSES
Net Profit
Net Profit= { [Sales * (1 - variable cost)] - fixed cost }
Sales= $11 million Variable Cost Fr. = 0.50 Fixed Cost= $2 million
AT-Profit
After-tax Profit = (Net Profit)*(Tax free fraction)
After-tax Profit = $3.5 million*0.75
Part-b
Keep the sales at $10 million and the other parameters But vary the Variable cost percentage Given Data: Product Sale: $10 million
Variable Cost = 50 percent of Sales Fixed Costs = $2 million Tax Rate= 35 percent
RESTS OF THE DATA IS THE SAME: Product Sale: $10 million Fixed Costs = $2 million Tax Rate= 35 percent
Tax free fraction = 1 (tax percentage on profit) TFF= 75% or 0.75
Net Profit
Net Profit= { [Sales * (1 - variable cost)] - fixed cost }
Sales= $10million Variable Cost Fr= 0.65 Fixed Cost= $2 million
AT-Profit
After-tax Profit = (Net Profit)*(Tax free fraction)
Conclusion
Part-a
Albert Einstein
Albert Einstein reportedly called compound interest mankind's "greatest invention."
COMPOUND INTEREST
Interest which is calculated not only on the initial principal but also the accumulated interest of prior periods.
OR
on interest,
F = P(1+ r/n)nt
Where: F = future value P = initial deposit r = interest rate (expressed as a fraction: e.g.. 0.06 for 6%) n = # of times per year interest is compounded t = number of years invested
Applies On..
Interest Rate
More is the Interest rate (r) more is the future amount
Compounding Frequency
More is the compounding frequency (n) for deposit more
Initial Amount
More is the principal amount (P) for deposit more is the future amount
Case Study(i)
If you start a bank account with amount $10,000 and your bank compounds the interest quarterly at an interest rate of 8%, how much money do you have at the 5th year's end ?
(assume that you do not add or withdraw any money from GIVEN DATA the account) P= $10,000
R= 0.08 N= 4 T= 5 years
F = 10000 (1+(.08/4))^(4*5)
F = 10000 (1+0.02)^(20)
F = 10000 (1.02)^(20) F = 10000 (1.4859)
Case Study(ii)
How much money would you need to deposit today at 9% annual interest compounded monthly to have $12,000 in the account after 6 years? GIVEN DATA
F= $12,000
R= 0.09
T= 6 years
12000 = P (1+(.09/12))^(12*6)
12000 = P (1+0.0075)^(72) 12000 = P (1.0075)^(72) 12000 = P (1.7125) P= $ 7007.3 So the principle amount should be 7007.3 dollars.
Case Study(iii)
If you deposit $5000 into an account paying 6% annual interest compounded monthly, how long until that the amount becomes double in the account?
GIVEN DATA
P = 5000 F = 10000 N = 12 R = 0.06
Compound Interest