ACTG 2010 Chapter Notes - Chapter 1: Interest Rate, Relyon, Dont

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6 Jul 2016

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Table 1. 1 - business/personal decisions that rely on accounting information: determine whether or not to buy a business and how much to pay o. Evaluate whether to lend to a prospective borrower, and at what interest rate. Assess whether or not you can afford to borrow money o o: decide if you can afford to go on vacation o. Find out how much money you have in the bank. Accounting isn"t a science, more an art. Accounting isn"t precise or exact, estimates must be used, uncertainty exists. Accounting doesn"t provide the "right" answer, more than one. Accounting: system for gathering data about an entity"s economic activity, processing, and organizing that data to produce useful information about the entity, and communicating that information to people who want to make decisions. Data: raw, unprocessed facts about an entity"s economic activity. Information: results from organizing & presenting data in ways that make it useful for decision-making.

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Small business management class.

Please answer the two questions from the article belowplease.

Q1)Which one of the techniques to increase cash inflows is bestillustrated in the article? Explain how you know. ?

Q2)Which one of the techniques to decrease cash outflows is bestillustrated in the article? Explain how you know. ?

The article:

The financial crisis on Wall Street is quickly spiraling down tosmall businesses, making it extremely difficult for them to securefrom large banks the credit they need to start and maintain theiroperations.

Some businesses that currently have good relationships withbanks are getting more scrutiny and higher interest rates -- suchas 15% or more. Riskier borrowers are being denied creditaltogether.

Aside from falling back on friends or family -- or charging upyet another credit card -- here's a look at five alternatives forgetting extra cash to run a business in this economy.

-- Peer-to-Peer Lending Sites

Several Web sites now facilitate loans between individuals whodon't know each other. Typically, the prospective borrowers createprofiles that include how much they need to borrow, what the moneywill be used for and some credit history.

Other individuals can browse the loan requests and make offersthat include payment terms and interest rates. Prospective lendersalso get a risk assessment of the borrower generated by the Website based on the borrower's credit history.

Some "peer-to-peer" lending sites include LendingClub.com,Prosper.com, RaiseCapital.com and Zopa.com.

On Prosper.com, for instance, 25% of borrowers are individualsrunning or looking to start businesses, says Chief Executive ChrisLarsen. The site facilitates loans between individuals from $1,000to $25,000, and interest rates on those loans right now range from6% for those with the strongest credit ratings to about 30%.

Prosper, which has 800,000 registered users, is seeing moreentrepreneurs with good credit scores signing up. "We're certainlyseeing a steady increase of the quality of borrower coming to oursite," Mr. Larsen says. About 55% of the loans being funded are forborrowers with credit scores above 720, he adds, while only about5% are for those categorized as "subprime" borrowers.

-- Community Banks, Credit Unions

While big banks are being battered by all the financial turmoilon Wall Street, many local banks and credit unions are far morestable.

In fact, community banks continue to expand, although some havesuffered losses on securities issued by troubled mortgage giantsFannie Mae and Freddie Mac, says Camden Fine, chief executive ofthe Independent Community Bankers of America, an industryassociation in Washington.

Still, he says, even the community banks are more hesitant tolend to companies that lack rock-solid balance sheets.

-- Factoring, Asset-Based Loans

Though certainly not a cheap route to capital, some banks andnon- bank financing companies offer financing that is backed by abusiness's assets or accounts receivable.

So-called factoring, where a lender might, say, outright give aborrower 80 cents on the dollar for the company's accountsreceivable, can be a good option for businesses like manufacturersthat are owed a lot of money by customers and that have no betterlending option right now, says Raphael Amit, an entrepreneurshipprofessor at the University of Pennsylvania's Wharton School.

Interest rates on such financing can sometimes run 15% orhigher, so it's best to only resort to this approach when there'sno lower-cost option.

So-called asset-based loans -- loans in which assets such asinventory, equipment or real estate are used as collateral -- canbe good options for companies with lots of assets. But again, ratestend to run much higher than on traditional bank loans. The loanamounts are often capped at a percentage of the assessed value ofthe assets, such as 65%.

Also, even loans backed by assets can be difficult to get forcompanies with less-than-stellar credit ratings. Mark Sunshine,president of First Capital, a West Palm Beach, Fla., financecompany, says he's seeing more demand for loans based on accountsreceivable or assets, but isn't necessarily doing much morebusiness. "There's a reason local banks won't lend them money," hesays of riskier small companies. He says he's sticking to companieswith lots of assets to use as collateral.

-- Negotiating With Customers or Suppliers

Another smart strategy for helping cash flow -- perhaps even ifyou do have access to loans -- is striking better payment termswith customers and suppliers, Prof. Amit says. Especially whenbusiness relationships are strong and long-lasting, many companiesare willing to help each other out in tough economies.

A business that usually gives customers 30 to 60 days to pay thebills, for instance, might require customers to pay upon receipt ofgoods. A supplier, on the other hand, might be willing to extendlengthier payment terms to a business customer if it feels thecustomer is trustworthy and vital to its own business. Somesuppliers also will lend money to their longstanding, most valuedcustomers.

-- Changing Behaviors

Hard times call for small businesses to be nimble andentrepreneurial. Many businesses are using the tough economy toscrutinize their business practices and find creative ways tocreate better cash flow.

Some turn to leasing instead of buying equipment they need.

Others are identifying areas of the business that will tend tobe more lucrative in today's economy and shifting their resourcesin those directions.

Management Accounting Application

In this assignment you will demonstrate your understanding ofcapital investment techniques by

evaluating the following three case studies.

Case Analysis 1:

You work for a small, local telecommunications company. In fiveyears, the company plans to undertake a major upgrade to itsservers and other IT infrastructure. Management estimates that itwill need up to

$450,000 to cover all related costs; however, as a fairly youngcompany, the goal is to pay for the

upgrade with cash and not to take out loans.

Right now, you have $300,000 in a bank account established forCapital Investments. This account pays

6% interest, compounded annually.

A member of the finance department has approached you with aninvestment opportunity for the

$300,000 that covers a five-year period and has the followingprojected after-tax cash flows:

Year Projected Cash Flow

1 $94,000

2 $114,000

3 $134,000

4 $114,000

5 $94,000

Based on this information, answer the following questions:

1) How much money will be in the bank account if you leave the$300,000 alone until you need it in five

years?

2) If you undertake the investment opportunity, what is theNominal Payback Period?

3) Using the factors for 6%, what is the Discounted PaybackPeriod?

4) What is the Present Value of the benefits from this 5-yearinvestment opportunity?

5) What is the Net Present Value of this investmentopportunity?

6) If you leave the money in the bank and earn 6% compoundedannually, will you have at least

$450,000 in 5 years to fund the server and IT upgrades? By howmuch will you be âoverâ or âshortâ of

what you need?

7) If you undertake the investment, will you have at least$450,000 in your checking account in 5 years?

By how much will you be âoverâ or âshortâ?

Case Analysis 2 :

The CEO of Dynamic Manufacturing was at a conference and talkedto a supplier about a new piece of

equipment for its production process that she believes willproduce ongoing cost savings. As the

Operations Manager, your CEO has asked for your perspective onwhether or not to purchase the

machinery.

After talking to the supplier and meeting with your Engineersand Financial Analysts, youâve gathered the

following pieces of data:

â¢ Cost of Machine: $150,000

â¢ Estimated Annual After Tax Savings: $65,000

â¢ Estimated machinery life: 3 years (after which there will bezero value for the equipment and no

further cost savings)

â¢ You seem to recall that Dynamicâs Finance organizationrecommends either a 10% or a 15%

discount rate for all Cost Savings Projects. You are fairly sureit is 10%.

You understand that you need to understand the projectfinancials to ensure that

this investment will be economically attractive to DynamicManufacturingâs shareholders.

Calculate the Nominal Payback, the Discounted Payback, the NetPresent Value and the IRR

assuming:

â¢ Part A, BASE CASE: 3 year project life, flat annual savings,10% discount rate

â¢ Part B. Saving Growth Scenario: BASE CASE but with 10%compounded annual savings growth

in years 2 & 3.

â¢ Part C, Higher Discount Rate Scenario: 3 year project life,flat annual savings, 15% discount rate

â¢ Part D, 5 Year Equipment Life:5 year project and savings life,flat annual savings, 10% discount

rate

Discussion â in a Word Document in paragraph form, respond tothe following:

1) From a Financial perspective, would you recommend thispurchase to Management? Which

scenario would you present and why?

2) In your opinion, which scenario is the most aggressive (i.eis based on the most aggressive

assumptions)? If you were to select this scenario as the basisfor your proposal, how would you

justify the more aggressive assumptions?

3) In SIMPLE English (as in talking to a non-Finance and non-MBAperson), explain why there was

a difference in outcome between Part A and Part B.

4) Beyond Financial measures, what other considerations wouldyou want to consider, before

making a recommendation to Management?

5) If you were the CEO, would you approve this proposal? Why orwhy not?

Case Analysis 3:

You are the General Manager at the Bicker, Slaughter and LynchLaw Firm. There is an opportunity to

buy out a small law firm that was just started by a young MBA/JDand you believe the firm can be grown

and become a lucrative part of your Firm.

With help from your Finance leader, you have estimated thefollowing benefit streams for this new

division:

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8
Before Tax Cash Flow FromOperations	$(149,000)	$-	$51,380	$88,760	$114,100	$129,780	$143,640	$167,300
After Tax Net Income FromOperations	$(103,500)	$(50,500)	$36,700	$63,400	$81,500	$92,700	$102,600	$119,500
After Tax Cash Flow FromOperations	$(85,600)	$15,000	$48,600	$72,200	$95,550	$101,300	$125,200	$140,200

You estimate that the purchase price for this firm would be$200,000 and that additional net working

capital would be needed in the amount of $60,000 in year 0, anadditional $20,000 in year 2 and then

$20,000 in year 5.

In addition to the purchase price, you would ask that yourAdvertising budget of $275,000 be increased by

an incremental one time amount of $50,000 in advertising in year0 to publicize the firmâs expansion.

Your Finance leader has indicated that the firm has access to acredit line and could borrow the funds at

a rate of 6%. He also mentions that when he runs Projecteconomics for Capital budgeting (such as a

new copier or a company car), he recommends a standard 10% ratediscount but the one other time they

looked at an acquisition of a smaller firm he used a 12% ratediscount.

At the end of 8 years, the plan will be to sell this division.The estimated terminal value (the sale and the

return of working capital) is conservatively estimated to be$300,000 of after tax cash flow help.

Calculate the N Nominal Payback, the Discounted Payback, the NetPresent Value and the IRR for this

potential acquisition.

Discussion â in a Word Document in paragraph form, respond tothe following:

1) From a Financial perspective, would you recommend thispurchase to Management? Why?

2) What are some of the non-financial elements that need to beconsidered for this proposal?

3) Assumptions in Project Economics can have a huge impact onthe result. Identify 3 financial

elements/assumptions in your analysis that would make thisproject not be financially attractive?

(E.g. Answer the question, what would have to be true for thisto be a bad investment?)

4) If you were the CEO would you approve this proposal? Why orwhy not?

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ACTG 2010 Chapter Notes - Chapter 1: Interest Rate, Relyon, Dont

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