HAAS SCHOOL OF BUSINESS

UGBA10

Principles of Business
Module 1, Lecture 2

John Briginshaw

Contact Details

Professor: John Briginshaw

Prof Email: john.briginshaw@berkeley.edu
Administrative: UGBA10@berkeley.edu
Office hours: Monday 10am 11am (also
after class)
Office F502J Haas
and dont forget to check out bcourses !!!

Learning Objectives for Today

Cost Structure and Break-even
Understand the difference between
Fixed cost: does not depend on units sold
Variable cost: rises as more units are sold

Follow-up in Discussion Calculation of

BREAKEVEN volume of sales units

Learning Objectives for Today

Business Financing
Understand the different roles of
Debt as a source of business financing
Equity as a source of business financing

The importance of Seniority of Debt

Sequence of equity funding
Key equity indicators
Follow-up next time: Tophat Question on
equity market capitalization

Lecture 2 Agenda
Cost Structure and Viability
Basic Business Financing

Using Debt to Finance a Business

Using Equity (Stock) to Finance a Business

Basic Principles of Cost Analysis

Costs are made up of variable and fixed costs
Variable costs these costs go up with sales
E.g. Ingredients, supplies or product
Hourly labor, commissions

Fixed costs these are the same however much you

sell
E.g. Rent
Fixed salaries

First get yourself a good business(!)

Profit = Sales costs
Where costs = fixed costs + variable costs
Suppose we have a product which sells for
$p and costs $v variable costs each unit
We have total fixed costs of $F
We sell n units

Profit = np nv F
p-v is called contribution margin

Example
Pippas Lemonade Stand
Glasses and table rental: $2 per day (to Mommy)
Price per lemonade: $0.60
Cost of lemon and sugar $0.40

How many glasses to sell to break even?

Each lemonade provides 20c of contribution
10 glasses to break even

What if: variable cost was 65c per glass?

Application
Think about Instacart (study.net reading)
$4 delivery charge
Pay shoppers $20 an hour
The shoppers deliver it to you

Estimated CM per order = Between -$6 and

-$16 (depends on speed of picking)

Whats their secret?

In this case the New York Times did not
quite get the whole story
Instacart applied 20 to 30% mark up
So, lets recalc the unit CM
Assume a $40 order takes 30 minutes to pick up
and deliver to customer
Instacart gets $40 x .25 + $4 = $14
Instacart pays picker $10 => Unit CM = $4

Now increasing fees and shifting to partner

Lecture 2 Agenda
Cost Structure and Viability
Basic Business Financing

Using Debt to Finance a Business

Using Equity (Stock) to Finance a Business

Basic Business Financing

Companies finance their assets by issuing
stockholders equity and debt
Stockholders equity (SE) is the issuance of
common stock
There must be at least one share of stock issued
by a company
The stockholder(s) is/are the owner(s) of the
company

Debt is borrowing by the company

Accounting Equation
All assets must be financed by either
stockholders equity or liabilities (debt)
This leads to the accounting equation
A=L+SE
Assets are economic resources that can be
useful to the company such as buildings and
equipment, inventory to sell to customers,
and financial assets such as cash to fund
future growth and expansion

Concept of Financial Seniority

Financial Seniority is the order in which
claims on the companys assets are paid if
the company is liquidated
Claims are comprised of liabilities and
stockholders equity (SE)
Liquidation is the sale of all assets for cash and
the payment of the cash to the investors who
hold claims

Rules of Financial Seniority

The basic rule is very simple: Liabilities
(debt) are paid first
In the event there is any cash remaining
after the debt is paid, that residual amount
is paid to stockholders.
Customarily, liquidation only takes place
when a company is in bad shape
Usually there is little left for stockholders
Sometimes, debtholders do not get paid in full!

Whats good about being residual??

However, what if things go well?
This means the company is worth a lot
Remember that debt or borrowing is repaid by
paying back the amount borrowed
i.e. Debt is a fixed claim
Equity gets the remaining value
It is this upside potential that makes equity
attractive as a long term investment

Debt vs Equity Summary

Borrowing aka Debt
High seniority
Legal right to be repaid and
to get interest before that
From the lenders (banks)
point of view: Lower risk,
lower reward
From the borrowers
(companys) point of view:
Risk of bankruptcy (BK) if
they cant pay the interest
Low cost of capital
No voting power for bank

Equity aka Common Stock

No seniority
No legal right to be repaid
but gets what is residual
From the stock investors
point of view: High risk,
high reward
From the issuers
(companys) point of view:

Never can cause bankruptcy

Only pay dividends if you can
High cost of capital
Lose voting power

Lecture 2 Agenda
Cost Structure and Viability
Basic Business Financing

Using Debt to Finance a Business

Using Equity (Stock) to Finance a Business

Financing the Business Firm

Secured Loan (Asset-Backed Loan)
Loan to finance an asset, backed by the borrower
pledging the asset as collateral to the lender

Collateral
Asset pledged for the fulfillment of repaying a loan
Examples of collateral

Land
Property (fixed assets)
Accounts receivable (financial asset)
Royalties from David Bowies music (intangible asset)
Im not kidding! Google Bowie Bonds

Financing the Business Firm (cont.)

Unsecured Loan
loan for which collateral is not required

Loan Principal
amount of money that is loaned and must be repaid

Interest
Periodic payments that must be made on a loan or
bond

Sale of Corporate Bonds

Corporate Bond
formal pledge obligating the issuer (the company)
to pay interest periodically (usually every 6
months) and repay the principal at maturity

Bond Indenture (Bond contract)

legal document containing complete details of a
bond issue

Maturity Date (Due Date)

future date when repayment of a bond principal is
due from the bond issuer (borrower)

Sale of Corporate Bonds (cont.)

Face Value (Par Value)
amount of money that the bond buyer (lender) will
receive on the maturity date

Default
failure of a borrower to make payment (of interest
or principal) when due to a lender

Bondholders Claim
request for court enforcement of a bonds terms of
payment

Lecture 2 Agenda
Cost Structure and Viability
Basic Business Financing

Using Debt to Finance a Business

Using Equity (Stock) to Finance a Business

Early Stages: Own Money, Angel

Investors and Venture Capital
Angel Investors
Outside investors who provide new capital for
firms in return for a share of equity ownership
In general, angels tend to invest smaller sums
than

Venture Capital (VC)

Private funds from wealthy individuals seeking
investment opportunities in new growth companies
May be managed by professional investors as a VC
fund

Later Stages: IPO, Stock Valuation

and Market Cap
Initial Public Offering (IPO)
First sale of a companys stock to the general public

Stock is valued based on future earnings

expectations
If profit margins or growth in profits is expected to be high,
a companys stock will be more valuable
Dividend yield is also a contributor

Market Capitalization (Market Cap)

total dollar value of all the companys outstanding shares

= share price x number of shares outstanding

Financial Comparison: CocaCola (KO) and PepsiCo (PEP)

EPS: Earnings per share = Net Income

Number of shares
outstanding

Key Measures of KO and PEP Stock

Dividend: cash payment paid by company to
the stockholder for each share they hold
Dividend yield = Annual Dividend Paid
Stock Price
Price Earnings (PE) Ratio = Stock price
EPS
Similar companies usually have similar PE
CHECK: Calculate PE ratio for KO and PEP

Corporation Sizes Based on

Capitalization

Most household name stocks are Large caps

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